In spring 2020, stay-at-home policies targeted at that contains multiplication from the coronavirus brought to some sharp loss of the revenues of nonfinancial firms. To shore up cash positions and ride the crisis, firms contacted their banks and came lower on pre-committed credit lines. Consequently, between early March and also the finish of April, the banking system was hit with a tidal wave of line of credit drawdowns (figure 1), believed at approximately half a trillion USD (Li et al. 2020). Banks could withstand the unparalleled credit demand, effectively supplying liquidity towards the real sector during a time period of stress. However, additionally they curtailed new loan originations and tightened lending standards by a degree not seen because the 2008 economic crisis (figure 2).
Figure 1. Line Of Credit Drawdowns by Listed Firms throughout the COVID-19 Crisis
A Bar chart depicting weekly line of credit drawdowns between March 2, 2020 and June 30, 2020.
Notes: The figure depicts weekly line of credit drawdowns between March 2, 2020 and June 30, 2020 for private and public firms with public debt that file 8-K regulatory filings using the Registration (in USD, billions). The figures only make reference to a subset of businesses that utilized their lines of credit during this time period.
Source: Authors’ calculations using S&P Global Market Intelligence, Leveraged Commentary and knowledge (LCD).
The loss of credit and also the tightening of lending standards claim that line of credit drawdowns might have affected banks’ attitudes toward risk-taking throughout the crisis, prompting these to become more careful in lending decisions. The pullback from lending might also happen to be brought on by the immediate or expected results of drawdowns on bank balance sheets (Acharya et al. 2021), despite banks entering the crisis with strong financial positions (Li et al. 2020).
Inside a recent paper (Kapan and Minoiu 2021), we empirically check out the outcomes of line of credit drawdowns and also the way to obtain bank credit, using data from the 3 segments from the financial loan market. The paper sheds light around the tension that may arise during crises between banks’ provision of liquidity insurance around the one hands, and sustaining the availability of credit however.
Did Line Of Credit Drawdowns Affect Bank Lending?
To reply to this, we employ data sets in the loan and bank levels to determine a hyperlink between bank contact with line of credit drawdowns and lending decisions. Our way of measuring bank contact with line of credit drawdown risk is offered by total outstanding credit commitments (made with the syndicated loan market), in percent of total assets, measured right before the start of the pandemic. While line of credit drawdowns really are a phenomenon affecting mainly large banks and enormous firms, our data sets cover lending outcomes for small and big borrowers, which helps us to document the crowding out results of drawdowns on other borrowers. Many of the important since pandemic has already established a substantial effect on smaller sized firms (Blossom et al. 2021 Bartik et al. 2020).
Figure 2. Alternation in Lending Standards, 1990-2020
A line chart depicting the internet percent of domestic banks that apparently tightened standards for industrial and commercial loans.
Notes: The figure depicts the internet percent of domestic banks that apparently tightened standards for industrial and commercial loans (positive values indicate a general tightening, on internet-more respondents stated they tightened than they eased). The chart implies that lending standards tightened considerably in the start of the pandemic-within the 2020:Q1 and particularly the 2020:Q2 survey-once the internet shares of banks that reported tightening rivaled individuals throughout the 2008 economic crisis, and ongoing to tighten in 2020:Q3, although in a slower pace. Laptop computer addresses alterations in the factors and terms on loans from banks within the quarter.
Source: Senior Loan Officer Opinion Survey from the U.S. Fed Board, public release.
We’ve two primary findings. First, we reveal that the biggest global banks, including U.S. banks, with greater exposures to drawdown risk reduced the availability of recent syndicated loans in 2020:Q2 greater than other banks. Around the intensive margin of loan adjustment towards the drawdown shock, more uncovered banks provided smaller sized loans, typically, towards the same customer in 2020:Q2 when compared with anytime during 2019. Around the extensive margin, more uncovered banks were less inclined to renew loans maturing in 2020:Q2, including lines of credit, and were less inclined to establish new lending relationships.
Second, we use bank-level data in the 2020 Senior Loan Officer Opinion Surveys (SLOOS) conducted through the Fed, which let us examine lending outcomes for small firms too (understood to be getting annual sales below $50 million). Tabulations from the raw data reveal that banks rich in contact with line of credit drawdown risk were more prone to tighten standards on new industrial and commercial loans and lines of credit during 2020:Q1-Q3 than banks with low exposure (figure 3). Inside a regression framework that controls for banks’ self-reported alterations in credit demand and balance sheet characteristics, we reveal that more uncovered banks indeed were relatively more prone to tighten the factors and relation to new loans in 2020. These effects are quantitatively more powerful and much more persistent for loans to small firms, echoing the findings of Chodorow-Reich et al. (2020), who document tighter use of credit for small firms throughout the pandemic. We reveal that small firms face a comparatively more powerful tightening of loans from more uncovered banks, on dimensions for example collateral needs, maximum maturity, and maximum size new lines of credit.
Figure 3. Alternation in Standards for Industrial and commercial Loans during 2020
A bar chart showing the fraction of banks reporting they tightened lending standards on industrial and commercial loans to small or large firms during 2020.
Notes: This figure shows the fraction of banks reporting they tightened lending standards on industrial and commercial loans to small or large firms during 2020 by size contact with line of credit drawdown risk (denoted CLE high CLE is above-mean drawdown risk and occasional CLE is below-mean drawdown risk).
Source: Senior Loan Officer Opinion Survey from the U.S. Fed Board, Refinitiv Dealscan, Call Report.
What’s the Mechanism That Ties Line Of Credit Drawdowns to Bank Lending?
We glance for evidence around the friction behind our results by analyzing banks’ survey responses on their own motivations to tighten lending standards in the 2020 SLOOS. This evidence highlights a huge role for alterations in risk tolerance at banks throughout the pandemic. A vital result and different contribution in our paper would be to reveal that banks with bigger exposures to drawdown risk were more prone to cite “lower risk tolerance” being an important reason behind tightening lending standards, controlling for balance sheet characteristics and shifts in loan demand. By comparison, concerns within the banks’ own liquidity and capital positions were only weakly associated with remarkable ability to allow loans in 2020, suggesting that balance sheet constraints aren’t the important thing friction driving our results. Rather, the important thing mechanism seems is the increase in risk aversion connected using the unpredicted boost in drawdowns, which introduced towards the forefront banks’ dormant off-balance sheet risks.
Policy Implications
Our results highlight the strain that may arise during crises between banks’ role as “lenders of first resort” (Li et al. 2020) as well as their fundamental purpose of offering credit, with implications for financial policy and financial stability. First, banks’ contact with pre-committed credit restrains financial intermediation after unpredicted surges in drawdowns, even if balance sheets are strong, which could hamper financial policy transmission. Second, a prudential metric from the Basel 3 regulatory framework-the liquidity coverage ratio (LCR)-must be revisited. Particularly, because of the high line of credit utilization rates in spring 2020-particularly in sectors seriously hit through the pandemic-the idea concerning the “stressed scenario” drawdown rate utilized in the LCR might need to be elevated in the current 10% to some more realistic 20%-30%.
The views expressed in the following paragraphs are ours and don’t reflect individuals from the staff, management, or policies from the Worldwide Financial Fund or even the Fed System.
References
Acharya, Viral V., Robert F. Engle, and Sascha Steffen. (2021). “Why did bank stocks crash during COVID-19?” NBER Working Paper No. 28559. National Bureau of monetary Research.
Bartik, Alexander W., Marianne Bertrand, Zoë B. Cullen, Edward L. Glaeser, Michael Luca, and Christopher T. Stanton. (2020) “How are small companies modifying to COVID-19? Early evidence from the survey.” NBER Working Paper No. w26989. National Bureau of monetary Research.
Blossom, Nicholas, Robert S. Fletcher, and Ethan Yeh. (2021) “The impact of COVID-19 upon us firms.” NBER Working Paper No. w28314. National Bureau of monetary Research.
Chodorow-Reich, Gabriel, Olivier Darmouni, Stephan Luck, and Matthew C. Plosser. (2020). “Bank Liquidity Provision over the Firm Size Distribution.” NBER Working Paper No. w27945. National Bureau of monetary Research.
Kapan, Tumer, and Camelia Minoiu (2021). “Liquidity Insurance versus. Credit Provision: Evidence in the Covid-19 Crisis.”
Li, Lei, Philip E. Strahan, and Song Zhang. (2020). “Banks as lenders of first resort: Evidence in the COVID-19 crisis.” Review of Corporate Finance Studies 9.3, pp. 472-500.