Cyclicality of Credit Supply: Firm Level Evidence
Harvard University; National Bureau of Economic Research (NBER)
Stockholm School of Economics
August 23, 2011
Harvard Business School Finance Working Paper No. 10-107
AFA 2011 Denver Meetings Paper
Theory predicts that there is a close link between bank credit supply and the evolution of the business cycle. Yet fluctuations in bank-loan supply have been hard to quantify in the time-series. While loan issuance falls in recessions, it is not clear if this is due to demand or supply. We address this question by studying firms’ substitution between bank debt and non-bank debt (public bonds) using firm-level data. Any firm that raises new debt must have a positive demand for external funds. Conditional on issuance of new debt, we interpret firm’s switching from loans to bonds as a contraction in bank credit supply. We find strong evidence of substitution from loans to bonds at times characterized by tight lending standards, high levels of non-performing loans and loan allowances, low bank share prices and tight monetary policy. The bank-to-bond substitution can only be measured for firms with access to bond markets. However, we show that this substitution behavior has strong predictive power for bank borrowing and investments by small, out-of-sample firms. We consider and reject several alternative explanations of our findings.
Number of Pages in PDF File: 48
Keywords: Banks, Financial Markets and the Macroeconomy, Business Cycles, Credit Cycles
JEL Classification: E32, E44, G21
Date posted: March 18, 2010 ; Last revised: January 22, 2014
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