Credit Market Conditions Research Articles

The Transmission of Monetary Policy Shocks

Commonly used instruments for the identification of monetary policy disturbances are likely to combine the true policy shock with information about the state of the economy due to the information disclosed through the policy action. We show that this signaling effect of monetary policy can give rise to the empirical puzzles reported in the literature, and propose a new high-frequency instrument for monetary policy shocks that accounts for informational rigidities. We find that a monetary tightening is unequivocally contractionary, with deterioration of domestic demand, labor and credit market conditions as well as of asset prices and agents’ expectations. (JEL D82, D84, E32, E43, E52, E58, G12)

Why are commercial loan rates so sticky? The effect of private information on loan spreads

Past studies find that commercial loan spreads are “sticky” in the sense that they do not fully respond to changes in open market rates or observable firm credit risk characteristics. In this paper, we provide evidence that the appearance of stickiness arises, in part, because the intensity of bank screening varies inversely with changes in both observable firm credit risk characteristics and credit market conditions. Our analysis demonstrates that stickiness in loan spreads does not necessarily indicate loan mispricing or misallocation of credit.

Banks' Market Power, Access to Finance, and Leverage

How does lending-market competitiveness affect new firms' financing? Using a unique US representative panel of new firms, we document that in more concentrated local lending markets: (i) new firms are less likely to access credit; (ii) new firms have lower leverage; and (iii) the best performing firms are more severely affected by reduced debt financing. We develop a contingent-claims model with monopolistically competitive banks that rationalizes these facts and shows how credit-market conditions determine loan fees and concentration. Our findings highlight banks' market power as a channel through which the financial sector influences firms' development and, hence, economic growth.

Impact of credit market conditions on agriculture productivity in Sub-Saharan Africa

PurposeThis study conducts an empirical analysis of the relationship between credit market conditions and agriculture output in Sub-Saharan Africa.Design/methodology/approachThis paper uses a two-stage least square instrumental variable and difference generalised method of moments dynamic panel model because potential reverse causation and endogeneity are addressed.FindingsThe findings show that better credit market conditions contribute to agriculture productivity. The results also show that better infrastructure and availability of agriculture inputs are associated with productivity improvements. The empirical results are robust when an alternative measure of agriculture productivity is used.Research limitations/implicationsAn important research agenda for future studies will be to consider alternative measures of credit market conditions and other intervening variables that influence the nexus. Besides, other methods that account for cross-sectional dependence could also be considered as the impact of credit on agriculture varies across the sub-regions.Practical implicationsThe findings make a case for enhancing credit market access to boost agriculture productivity. There is also a need to implement financial education programs for farmers and ensuring continuous engagement with farmers.Originality/valueAlthough the issue of agriculture finance has been well documented in the literature, few studies have estimated the elasticity of agriculture productivity to changes in credit conditions. Also, our consideration of the intervening role of infrastructure amongst others is an area that has remained relatively unexplored.

Uptake of the Main Street Lending Program

The Main Street Lending Program (Main Street) was one of several new credit facilities launched by the Federal Reserve and the U.S. Department of the Treasury (Treasury) in response to the COVID-19 pandemic. The Federal Reserve published draft terms for Main Street on April 9, 2020, and the program started purchasing loan participations on July 6, 2020, with the goal of supporting lending to a wide range of small and medium-sized businesses that were in sound financial condition before the onset of the COVID-19 pandemic. When the program’s draft terms were first circulated, pandemic-related closures were taking hold throughout the economy, firms were sharply drawing down their existing credit lines, and credit market conditions were extremely tight. Against this backdrop, Main Street was intended to support the flow of credit to small and, especially, medium-sized firms and nonprofit organizations, as such entities were often too large to benefit from the Paycheck Protection Program (PPP) and too small to benefit directly from Federal Reserve facilities supporting the corporate bond and commercial paper markets.

Borrowers' perceptions of lending conditions: worlds apart or closer than close

Given that lenders and borrowers interact in the same (credit) market, an interesting research question that arises is whether the demand side of the market correctly comprehends the actual credit market conditions that are primarily shaped by the supply side. We explore this by utilising available surveys conducted separately for the two sides of the credit market and empirically investigate whether, and by which mechanism, demand-side perceptions relate to supply-side credit conditions. Our results indicate that demand-side perceptions do not match one-for-one supply-side conditions, but are rather described by an adaptive mechanism. This mechanism suggests that demand-side perceptions are modified every period by a fraction of the last period's perception error. Additionally, we find that demand-side perceptions systematically overshoot the actual conditions, and this overshooting is accentuated for periphery countries and smaller firms.

Foreign Currency Borrowing and Risk Exposure of Firms: An Emerging Market Economy Viewpoint

Foreign currency borrowings by emerging market corporations have increased significantly in the post-global financial crisis. Extant literature has mainly focused on the cause of the increase in foreign currency borrowings. In this paper, we study the consequences of the increase in foreign currency borrowings. We examine the role that foreign currency borrowings play in transmitting the risks associated with changes in global credit market conditions and currency mismatch risk to the domestic firms. We use the data of non-financial Indian firms listed in the Bombay Stock Exchange and National Stock Exchange to do our analysis. We find that foreign currency borrowings increase the risk exposure of the firms. Furthermore, foreign currency borrowings play a crucial role in transmitting global credit liquidity risk and currency risk to domestic firms. Overall, our results indicate that too much foreign currency borrowings may pile risk in the financial system that may become a cause of concern.

Credit Refinancing and Tax Avoidance

This paper examines the disciplining effects of credit markets on corporate tax avoidance strategies. We show that, during adverse credit market conditions, firms with refinancing needs prefer to forgo the after-tax cash flow benefits of tax avoidance to regain the access to the traditionally risk-averse credit markets. Our results show that firms increase their effective tax rate by 2 percentage points when facing refinancing constraints. This effect is more pronounced for firms with lower asset tangibility and higher default probability. Adverse credit market conditions together with refinancing needs prompt firms to become more conservative in their future tax avoidance strategy for up to three years. Moreover, we show that firms engage in less tax deferral strategies, while leaving their leverage and debt shield unchanged. Overall, these findings are consistent with credit markets putting pressure on tax avoiding firms.

Small and Vulnerable

We provide broad-based evidence of a firm size premium of total factor productivity (TFP) growth in Europe after the Global Financial Crisis. The TFP growth of smaller firms was more adversely affected and diverged from their larger counterparts after the crisis. The impact was progressively larger for medium, small, and micro firms relative to large firms. It was also disproportionally larger for firms with limited credit market access. Moreover, smaller firms were less likely to have access to safer banks: those that were better capitalized banks and with a presence in the credit default swap market. Horseraces suggest that firm size may be a more important and robust vulnerability indicator than balance sheet characteristics. Our results imply that the tightening of credit market conditions during the crisis, coupled with limited credit market access especially among micro, small, and medium firms, may have contributed to the large and persistent drop in aggregate TFP.

The US financial crisis, market volatility, credit risk and stock returns in the Americas

We employ the multivariate DCC-GARCH model to identify contagion from the USA to the largest developed and emerging markets in the Americas during the US financial crisis. We analyze the dynamic conditional correlations between stock market returns, changes in the general economy’s credit risk represented by the TED spread, and changes in the US market volatility represented by the CBOE Volatility Index® (VIX). Our sample includes daily closing prices from January 1, 2002 to December 31, 2015, for the USA and stock markets in Argentina, Brazil, Canada, Chile, Colombia, Mexico, and Peru. We first identify that increases in VIX have a negative intertemporal and contemporaneous relationship with most of the stock returns, and these relationships increase significantly during the US financial crisis. We then find evidence of significant increases in contemporaneous conditional correlations between changes in the TED spread and stock returns. Increases in conditional correlations during the financial crisis are associated with financial contagion from the USA to the Americas. Our findings have policy implications and are of interest to practitioners since they illustrate that during periods of financial distress, US stock volatility and weakening credit market conditions could promote financial contagion to the Americas.

Information asymmetry and self denial in gender participation in commercial banks’ credit markets in emerging economies in Ghana

Micro and small women entrepreneurs’ participation in commercial banks’ credit markets remains a huge challenge even after the liberalization of the financial sector. The present study sought to examine factors that influence gender participation in the credit markets of commercial banks. The sample size comprised 678 respondents to questionnaires for the study. At the individual level, the study tested that no significant relationship exists between a borrower’s individual characteristics and credit participation, and that no significant relationship exists between individual’s gender and credit participation. Also, at the firm level, the study tested that no significant relationship occurs between credit market conditions and credit market participation, and that no significant relationship occurs between individual’s firm characteristics and credit market participation. However, the findings reject all these null hypotheses for the alternates. Using the Heckman two-step model, we observed that participation increases for male and the young, entrepreneurs in the commerce sector, those closer to the bank and those who have previously participated in the market. Yet, participation reduces for entrepreneurs with secondary education and those with larger household size. Also, the likelihood to participate is influenced by being a male, having larger assets value and easiness of loan processing. Moreover, the Fairlie decomposition analysis shows a credit participation gap between men and women entrepreneurs that is largely influenced by differences in their individual and firm characteristics. The major implication is that male entrepreneurs have more favorable individual, firm and credit market conditions than female entrepreneurs for credit market participation. Thus, government policies to empower women are desirable.

Export Regulations, Credit Markets, and Corruption: Implications for Internationalization

We study how key dimensions in the home country institutional environment – credit markets environment, export regulation, and corruption – affect firm internationalization via exporting and outward foreign direct investment (OFDI). We conduct our study using country- level data from 96 developed and developing countries between 2000 and 2018. Our results provide novel insights on the channel of internationalization as a response to changes in home country export regulations, credit market development, corruption. Changes in home- country institutions effect mainly type of firm internationalization, with the differences in the relationship between institutions and OFDI mainly associated with credit market conditions.

The determinants of bank loan recovery rates in good times and bad – New evidence

We find that factors explaining bank loan recovery rates differ depending on the state of an underlying credit cycle. Our modelling approach incorporates a two-state Markov switching mechanism to capture underlying economic conditions. This latent credit cycle variable helps to explain differences in observed recovery rates over time. Using US bank default loan data from Moody’s Ultimate Recovery Database and covering the pre-and post-global financial crisis (GFC) period, the paper develops and implements a dynamic model for bank loan recovery rates. We accommodate the distinctive empirical features of the recovery rate data, while incorporating a large number of possible determinants. We find that certain loan-specific and other variables hold different explanatory power with respect to recovery rates in ‘good’ versus ‘bad’ times in the credit cycle, i.e. depending on underlying credit market conditions. Our findings demonstrate the importance of accounting for counter-cyclical expected recovery rates when determining capital retention levels.

Rollover risk and credit spreads in the financial crisis of 2008

This paper investigates the asset pricing implications of rollover risk, i.e., the risk that firms might not be able to refinance their due liabilities. I find that firm-specific rollover risk coupled with deteriorating credit market conditions significantly increase firms' credit spreads. During the 2008–2009 financial crisis period, the one-year CDS spreads for high rollover risk firms are 32–72 basis points higher than the spreads of low rollover risk firms. Longer maturity CDS spreads show similar patterns with smaller magnitudes. During normal periods, however, CDS spreads are mostly explained by fundamental variables and rollover risk is not a significant determinant. Similar rollover risk effect is also observed in other financial markets, including corporate bond, stock, and options markets.

Dynamic nonlinear impacts of oil price returns and financial uncertainties on credit risks of oil-exporting countries

Abstract This paper investigates the dynamic and nonlinear impact of oil price returns on the sovereign credit default swap (CDS) spreads for the oil-rich countries of the Gulf Cooperation Council (GCC) and other important oil-exporting countries, namely Venezuela, Mexico and Russia. We employ the standard quantile regression analysis, the rolling quantile regression, and finally, the Quantile-on-quantile (QQ) approach that allows one to investigate the dependence dynamics of the sovereign CDS spreads under different credit market conditions. The empirical results show that oil price returns significantly and favorably decrease the sovereign credit risk premium of the non-GCC oil-exporting countries under consideration. However, the results also suggest no or little impact on the sovereign credit risk premium of Saudi Arabia, UAE and Norway, which have the most significant sovereign wealth funds in the world. The negative (i.e. favorable) impact of oil price returns on the sovereign CDS spreads, where present, gradually increases with the quantile level and is the highest during the bullish credit market conditions. The results also show that those CDS spreads are more sensitive to the global bond market uncertainty factor than to the global equity market uncertainty factor.

Managerial ownership, credit market conditions, undervaluation and offer premiums in management (MBOs) and leveraged buyouts (LBOs)

This paper investigates the impact of lending conditions and undervaluation on the buyout choice and offer premiums in MBO versus LBO decisions. We control for endogeneity and self-selection using a two-stage regression model in a sample of US transactions. Firms with higher insider ownership are more likely to select an MBO, whereas easy lending conditions increase the likelihood of an LBO. Determinants of offer premiums are also significantly different. Our main conclusion is that many factors (in addition to managerial ownership) should be accounted for to better understand the sources of value creation in going private transactions.

Transient Institutional Ownership, Costly External Finance, and Corporate Cash Holdings

We investigate how transient institutional ownership influences the level and value of cash holdings. We show that transient institutional ownership has a positive effect on cash holdings, and this linkage is more pronounced when stock and credit market conditions are less favorable. Transient institutions exacerbate debt-holder-shareholder conflicts (e.g., short-termism) and increase stock price crash risk, thereby increasing the cost of debt. Overall, our results suggest that transient institutions make cash holdings more valuable because financing by debt becomes more costly.

Credit market conditions and impact of monetary policy in a developing economy context

This research examines the impact of monetary policy tools on macroeconomic variables through a nonlinear specification of threshold structural vector auto- regression (TVAR) using broad money and reverse repo rate as policy variables and output growth and inflation rate as macroeconomic variables. This research employs net domestic credit and interest rate spread as alternative threshold variables while segmenting the time 2001 m12-2018 m5 as easy and tight credit regimes in Pakistan. This research analyses the generalised impulse response functions for each threshold variable to specify the effects of monetary policy shocks. Current research finds that for one to two years’ time horizon; an increase in broad money has positive and long-time effect on output growth especially when interest rate spread is above its threshold value (i.e. easy credit regime). While a decrease in reverse repo rate brings a short-term positive effect on output growth whereas, an increase in reverse repo rate reduces the inflation for relatively longer time especially when economy is following an easy credit regime. This research identifies changes in broad money as an effective tool to enhance output growth and changes in reverse repo rate to control inflation rate in Pakistan.

Small and Vulnerable: Small Firm Productivity in the Great Productivity Slowdown

We provide broad-based evidence of a firm size premium of total factor productivity (TFP) growth in Europe after the Global Financial Crisis. The TFP growth of smaller firms was more adversely affected and diverged from their larger counterparts after the crisis. The impact was progressively larger for medium, small, and micro firms relative to large firms. It was also disproportionally larger for firms with limited credit market access. Moreover, smaller firms were less likely to have access to safer banks: those that were better capitalized banks and with a presence in the credit default swap market. Horseraces suggest that firm size may be a more important and robust vulnerability indicator than balance sheet characteristics. Our results imply that the tightening of credit market conditions during the crisis, coupled with limited credit market access especially among micro, small, and medium firms, may have contributed to the large and persistent drop in aggregate TFP.

Extrapolation and Cognitive Dissonance in the Market for Credit Risk

A measure of heterogeneous beliefs based on the high-frequency credit market information is associated with an increase in the firm's debt issuance and investments and a decrease in the cost of debt the following month. Inferring an elevated credit-market belief as investors' optimistic outlook on firms' prospects predicts future credit returns. Expectations move with the leverage (moneyness) levels and correlate with risk factors. The existence of predictable mean reversion in credit market conditions reinforces these results.