Do Banks Propagate Debt Market Shocks?
45 Pages Posted: 13 Oct 2009 Last revised: 25 Mar 2010
Date Written: March 24, 2010
Over the years, U.S. banks have increasingly relied on the bond market to finance their business. This created the potential for a link between the bond market and the corporate sector whereby borrowers, including those that do not rely on bond funding, became exposed to the conditions in the bond market. We investigate the importance of this link.
Our results show that when the cost to access the bond market goes up, banks that rely on bond financing charge higher interest rates on their loans. Banks that rely exclusively on deposit funding follow bond financing banks and increase the interest rates on their loans, though by smaller amounts. Further, banks pass the bond market shocks predominantly to their risky borrowers that have access to the bond market and to their borrowers that do not have access to the bond market. These results show that banks propagate shocks to the bond market by passing them through their loan policies to their borrowers, including those that do not use bond financing.
Keywords: Bank subdebt, bond spreads, lending channel, loan spreads
JEL Classification: E51, G21, G32.
Suggested Citation: Suggested Citation