Abstract
We study the channels by which the risk of future funding shocks to large
U.S. banks affects their ex-ante supply of credit to corporate borrowers. First, we
establish that the main source of bank funding risk is the need, under stressed
market conditions, to fund drawdowns of pre-committed revolving credit lines.
Until recently, banks have mitigated this funding risk by linking the interest rates
paid on credit lines to risk-sensitive reference rates such as the London Interbank
Overnight Rate (LIBOR). Second, we show that incentives to provide credit lines
are dampened by the debt-overhang cost to bank shareholders associated with
funding stressed-market drawdowns. However, the associated adverse effect
on credit supply is attenuated if: (1) drawdowns are expected be re-deposited
at the same bank, which was the dominant outcome at the COVID shock of
March 2020, and (2) revolvers are linked to credit-sensitive reference rates such
as LIBOR that reduce borrower incentives to draw more heavily on their lines
during stressed markets. Third, we estimate how the replacement of LIBOR with
risk-free alternative reference rates will affect the supply of revolving credit.
For more information please visit the Stern Wednesday Finance Seminar Website or contact Lindsay Anderson