Bank Lines of Credit in Liquidity Management - The Impact of Recall Risk for German SMEs

Abstract

We use a unique sample of self-employed and corporate clients provided by a universal bank in Germany to investigate how recall risk of recallable bank lines of credit impact cash holdings and line usage. While the bank does not require an upfront fee for providing a line of credit, which may make these lines an effective tool in liquidity management, the bank has the right to recall the line upon short notice. Based on theoretical considerations, we postulate that clients with low recall risks have lower cash holdings and higher line usages than clients with moderate recall risks. In turn, the latter have higher cash holdings and lower line usage than clients with high recall risks, whose recall risk comes along with financial distress. Our findings indicate that the recall risk has a non-linear and non-monotonic effect on cash holdings and line usages and that this effect is not driven by other line characteristics.