Reduce Credit Supply Research Articles

Sharing the Pain? Credit Supply and Real Effects of Bank Bail-Ins

We analyze the credit supply and real sector effects of bank bail-ins by exploiting the unexpected failure of a major Portuguese bank and subsequent resolution. Using a matched firm-bank dataset on credit exposures and interest rates, we show that while banks more exposed to the bail-in significantly reduced credit supply at the intensive margin, affected firms compensated the tightening of overall credit with other sources of funding. Nevertheless, SMEs were subject to a binding contraction of funds available through credit lines and reduced investment and employment. These dampening effects are explained by the pre-shock internal liquidity position of smaller firms.

Unintended Consequences of Government Bailouts: Evidence from Bank-Dependent Borrowers of Large Banks

Using the Troubled Asset Relief Program (TARP) as a laboratory, this paper examines the impacts of bank bailouts on bank-dependent clients. We find that large TARP recipient banks reduce credit supply to dependent borrowers in the post-TARP period. Such effect is more pronounced when recipient banks hoard more liquidity ex-post. We further show that a large fraction of credit supply reduction is due to regulatory uncertainty. This negative shock via credit channel causes dependent borrowers to become more constrained financially. Ex-ante analysis also reveals a significant valuation loss for these borrowers around the announcements of their main banks’ TARP approvals.

Unsecured Credit Supply, Credit Cycles, and Regulation

This paper explores the dynamics of unsecured credit supply over the recent credit cycle and around the passage of the CARD Act. We examine a unique data set of over 200,000 credit card mail solicitations to a representative sample of households and introduce credit card offers as a direct, informative measure of supply of such credit. Contrasting personal credit card offer dynamics before and after the passage of the CARD Act with those of personal loans, auto loans, and corporate credit cards, we find that lenders reduced credit supply of personal credit cards to nonprime borrowers in response to the CARD Act. Our analysis highlights the importance of separately examining supply and demand responses to assess the unintended consequences of regulation. Received January 30, 2016; editorial decision August 9, 2017 by Editor Philip Strahan.

Credit Demand and Supply: A Two-Way Feedback Relation

The model developed in this paper extends the framework of self-fulfilling credit market freezes proposed by Bebchuk and Goldstein (2011) by endogenizing firms' investments decisions. The existence of an aggregate investment threshold below which individual investment projects are unsuccessful creates a coordination failure not only among banks but also among firms and, crucially, between the two sides of the market. Because of the resulting strategic complementarities between firms and banks, low credit demand expectations reduce credit supply and viceversa. This two-way feedback loop explains why a severe slump in aggregate demand may be associated with a disruption in lending caused by a financial crisis. Replies to the euro area Bank Lending Survey by individual Italian banks provide support to the model's conclusions.

Effect of Bank Mergers on Client Firms: Evidence from the Credit Supply Channel

This study investigates the effects of bank mergers on client firms. A rich panel of data detailing firm borrowing from individual banks enables controls for demand-side effects to isolate the effect of bank mergers on the supply of credit. The impact of bank mergers on other firm outcomes (growth in total borrowing, distance to default and investment) is also examined. A merger announcement by a firm’s main bank results in a contraction in credit supply from the merging bank. Firms are not able to compensate for the reduced credit supply from the main bank, so overall borrowing also declines.

Credit Supply During a Sovereign Debt Crisis

We study the patterns of credit supply in Italy following the burst of the European sovereign debt crisis in 2011. Comparing lending to the same firm, we find that domestic banks reduced credit supply, increased interest rates on credit granted, and lowered the probability of accepting loan applications more than foreign banks, which were less affected by the sovereign crisis. The credit contraction is the consequence of a largely country-specific effect, not explained by heterogeneity in bank characteristics, but associated to a generalized increase in the cost of funding of Italian banks. Looking across firms, we find that credit restrictions by domestic banks were not fully compensated by foreign banks’ lending, implying that Italian firms experienced an aggregate credit shortage.

Lending Implications of U.S. Bank Stress Tests: Costs or Benefits?

The U.S. bank stress tests aim to improve financial system stability. However, they may also affect bank credit supply. We formulate and test opposing hypotheses about these effects. Our findings are consistent with the Risk Management Hypothesis, under which stress-tested banks reduce credit supply – particularly to relatively risky borrowers – to decrease their credit risk. The findings do not support the Moral Hazard Hypothesis, in which these banks expand credit supply – particularly to relatively risky borrowers that pay high spreads – increasing their risk. Results are generally stronger for safer banks, banks that passed the stress tests, and the earlier stress tests.

Effect of Bank Capital Requirements on Bank Risk-taking and Financial Stability

This paper reviews theoretical and empirical studies on the way that capital requirements influences bank capital structure, risk-taking and lending. Deposit insurance, when not fairly priced, give incentives for excessive risk-taking. To alleviate this problem regulator found as necessary the use of certain requirements such as capital requirement. Based on this, it is obligatory for banks to hold more capital that means to have more of their own funds at risk. The theoretical literature related to the way how capital regulation influences banks on their decision for the capital structure and portfolio risk says more than that. Capital requirements were supposed to enhance financial stability and economic growth. Regarding economic growth, the effects of capital requirements can influence it directly or indirectly. Changes that capital requirements bring to the credit supply, costs of capital and to the bank asset risks affect indirectly the economic growth. Higher capital requirements reduce credit supply and decreases credit demand which in turn may slow down economic growth. Nevertheless, well-capitalized banks make provision of credit more consistent and enhance financial stability. Suggestions given from the theoretical literature and lessons learned from empirical researches are going to be used in analyzing effects of bank capital requirements on the relation between efficiency, capital and risk-taking in Albanian banking system DOI: 10.5901/mjss.2016.v7n1p340

From Financial to Real Economic Crisis: Evidence from Individual Firm-Bank Relationships in Germany

What began as a financial crisis in the United States in 2007–2008 quickly evolved into a massive crisis of the global real economy. We investigate the importance of the bank lending and firm borrowing channel in the international transmission of bank distress to the real economy—in particular, to firm investment. We exploit a unique data set for Germany that contains firm-level financial statements for the 2004–2010 period together with the financial statements of each firm’s relationship bank(s). The data include small and medium-sized firms. Using instrumental variable estimations in first differences to eliminate firm- and bankspecific effects, we find that banks that were affected at the onset of the financial crisis due to proprietary trading activities reduce their lending more strongly than nonaffected banks. Firms whose relationship banks reduced lending downsized their real investment significantly. This effect was larger for smaller and younger firms and for firms that were unable to provide much collateral. We also document that some of the firms partially offset reduced credit supply by using internal funds, issuing new equity, and establishing new bank relationships.

Effect of Bank Capital Requirements on Economic Growth: A Survey

This paper reviews studies exploring how higher bank capital requirements affect economic growth. There is little evidence of a direct effect; research focuses on the indirect effects of capital requirements on credit supply, bank asset risk, and cost of bank capital, which in turn can affect economic growth. Banks facing higher capital requirements can reduce credit supply as well as decrease credit demand by raising lending rates which may slow down economic growth. However, having better-capitalized banks enhances financial stability by reducing bank risk-taking incentives and increasing banks' buffers against losses.

From Financial to Real Economic Crisis: Evidence from Individual Firm-Bank Relationships in Germany

What began as a financial crisis in the United States in 2007-2008 quickly evolved into a massive crisis of the global real economy. We investigate the importance of the bank lending and firm borrowing channel in the international transmission of bank distress to the real economy - in particular, to real investment and labor employment by nonfinancial firms. We analyze whether and to what extent firms are able to compensate for the shortage in loan supply by switching banks and by using other types of financing. The analysis is based on a unique matched data set for Germany that contains firm-level financial statements for the 2004-2010 period together with the financial statements of each firm's relationship bank(s). We use instrumental variable estimations in first differences to eliminate firm- and bankspecific effects. The first stage results show that banks that suffered losses due to proprietary trading activities at the onset of the financial crisis reduced their lending more strongly than non-affected banks. In the second stage, we find that firms whose relationship banks reduce credit supply downsize their real investment and labor employment significantly. This effect is larger for firms that are unable to provide much collateral. We document that firms partially offset reduced credit supply by establishing new bank relationships, using internal funds, and issuing new equity.

Does bank ownership affect lending behavior? Evidence from the Euro area

We analyze the differences in lending policies across banks characterized by different types of ownership, using micro-level data on Euro area banks during the period 1999–2011 to detect possible variations in bank lending supply responses to changes in monetary policy. Our results identify a general difference between stakeholder and shareholder banks: following a monetary policy contraction, stakeholder banks decrease their loan supply to a lesser extent than shareholder banks. A detailed analysis of the effect among stakeholder banks reveals that cooperative banks continued to smooth the impact of tighter monetary policy on their lending during the crisis period (2008–2011), whereas savings banks did not. Stakeholder banks’ propensity to smooth their lending cycles suggests that their presence in the economy has the potential to reduce credit supply volatility.

Balance Sheet Strength and Bank Lending During the Global Financial Crisis

We examine the role of bank balance sheet strength in the transmission of financial sector shocks to the real economy. In particular, we exploit variation in banks’ wholesale funding reliance and their capital levels in 2007Q2 to estimate the impact of bank liquidity shocks in 2007-2008 on the supply of large corporate loans and real economic outcomes. We find that banks with ex-ante stronger balance sheets were better able to maintain lending during the global financial crisis. Banks that were more dependent on market funding reduced the supply of credit more than other banks during the crisis but higher levels of better-quality capital mitigated this effect. Reduced credit supply translated into lower economic activity for firms borrowing from thinly-capitalized banks, suggesting there was limited scope for credit substitution across lenders or debt markets. These findings indicate that strong financial intermediary balance sheets are key for the recovery of credit and economic performance after large financial sector shocks. They also support regulatory steps to boost high-quality capital buffers under the Basel III framework.

On the spillover of exchange rate risk into default risk

In order to reduce the exchange-rate risk, banks in emerging markets are typically denominating their loans in foreign currencies. However, in the event of a substantial depreciation of the local currency, the payment ability of a foreign-currency borrower may be reduced significantly, exposing the lender to additional default risk. This paper analyses how the exchange-rate risk of foreign currency loans spills over into default risk. We show that in an economy where foreign currency loans are a dominant source of financing economic activity, depreciation of the local currency establishes a negative feedback mechanism that leads to higher default probabilities, reduced credit supply, and reduced growth. This finding has some important implications that may be of special interest for regulators and market participants in emerging economies.

The Macroeconomic Implications of the New Basel Accord

This paper assesses the macroeconomic implications of Basel II in light of recent development in the literature. It argues that although Basel II is likely to strengthen banks' incentives to control their risk-taking, it may reduce credit supply to certain borrowers, such as small- and medium-sized enterprises (SMEs) and firms based in developing countries. Furthermore, Basel II may increase procyclical fluctuation of bank loans while weakening the monetary transmission mechanism during recessions. A widespread adoption of the through-the-cycle risk models may mitigate these problems, but not completely eliminate them. This paper also considers whether monetary policy can be used to counter effectively the procyclicality problem inherent in Basel II. (JEL E52, G21, G28)