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Financing Frictions and Their Impact on Liquidity

Paper Session

Friday, Jan. 5, 2018 10:15 AM - 12:15 PM

Loews Philadelphia, Commonwealth Hall C
Hosted By: American Finance Association
  • Chair: Stacey Schreft, U.S. Office of Financial Research

Asset-side Bank Runs and Liquidity Rationing: A Vicious Cycle

Zongbo Huang
The Chinese University of Hong Kong, Shenzhen


This article studies the role of bank liquidity rationing in managing panics in a dynamic model of credit line run. In downturns banks tighten liquidity by cutting credit lines. Anticipating this, borrowers run to draw down credit lines in the first place, which imposes further pressure on banks. Thus liquidity rationing and credit line runs form a feedback loop that amplifies bank distress. I fit the model to the U.S. commercial bank data and find that the feedback effects contribute to about two-thirds of the total credit contraction in downturns. From a normative perspective, a commitment tax on cutting credit lines is effective in mitigating runs.

Financial Intermediaries, Corporate Debt Financing, and The Transmission of Systemic Risk

Christian Lundblad
University of North Carolina
Zhongyan Zhu
Monash University


We revisit the spillover effects to non-financial, corporate borrowers from a systemic event in which a number of large, important banks simultaneously become imperiled. To shed light on this question, we build a novel, comprehensive dataset, covering both firms’ borrowing activities through bank loans, revolvers, corporate bonds, and commercial paper and the particular institutions to which they are connected. We demonstrate that while there are over one thousand financial institutions active in facilitating the borrowing activity of non-financial firms before the financial crisis, roughly 80% is facilitated by a group of large, central institutions. As many of these central institutions approach the edge of failure during the crisis, we uncover significant cross-sectional variability in the degree to which non-financial firms are affected, depending upon whether and how these firms rely on external debt financing. First, the one-third of firms that (largely) do not rely on external debt financing exhibit limited exposure to the systemic event. Second, for the remaining firms that do rely on external debt financing, the cross-sectional variation in their crisis exposure is mainly driven by measurable pre-crisis connections to the central financial institutions. Further, crisis exposures do not appear to be significantly lower for those firms that exhibit multiple bank connections or have access to the public debt market. The often-hypothesized means of diversifying funding risks appear to be limited in an episode where the central institutions are collectively impaired.

The Loan Covenant Channel: How Bank Health Transmits to the Real Economy

Gabriel Chodorow-Reich
Harvard University
Antonio Falato
Federal Reserve Board


We document the importance of covenant violations in transmitting bank health to nonfinancial firms using a new supervisory data set of bank loans. More than one-third of loans in our data breach a covenant during the 2008-09 period, providing lenders the opportunity to force a renegotiation of loan terms or to accelerate repayment. We find that lenders in worse health are less likely to grant a waiver and more likely to force a
reduction in the loan commitment. Quantitatively, the reduction in credit to borrowers with long-term credit but who violate a covenant accounts for a nearly 12\% decline in the volume of loans and commitments outstanding between 2007 and 2009, slightly larger than the total contraction in credit during that period. We conclude that the bank lending channel is largely a loan covenant channel.
Phil Dybvig
Washington University-St. Louis
Victoria Ivashina
Harvard Business School
Sudheer Chava
Georgia Institute of Technology
JEL Classifications
  • G2 - Financial Institutions and Services