How Much Liquidity Insurance Do Credit Lines Provide?

60 Pages Posted: 9 Nov 2011 Last revised: 22 Jul 2017

See all articles by Zhaohui Chen

Zhaohui Chen

University of Virginia - McIntire School of Commerce

Yan Hu

University of La Verne

Kose John

New York University (NYU) - Department of Finance

Connie X. Mao

Temple University - Fox School of Business and Management

Date Written: July 21, 2017

Abstract

To what extent do credit lines provide liquidity insurance? We investigate this question using a unique dataset with firms’ actual draw-down rates and find that firms draw down their lines of credit at higher rates than the initial contract rates recorded in Dealscan. More importantly, we find that, on average, firms borrow at 7-8 basis points below market rates by drawing down their credit lines. The draw-down rate benefit is small compared with the cost paid to maintain a credit line. Firms enjoyed a significant draw-down rate benefit during the 2007-2009 financial crisis, as well as when they borrow from relationship banks and more reputable banks. We also explore an alternative explanation for credit line uses. Consistent with the convenience hypothesis, we find that firms are more likely to draw down credit lines than obtaining new loans during times of greater short-term financing needs.

Keywords: Lines of credit, liquidity insurance, bank reputation, lending relationship, moral hazard.

JEL Classification: G21, G32

Suggested Citation

Chen, Zhaohui and Hu, Yan and John, Kose and Mao, Connie X., How Much Liquidity Insurance Do Credit Lines Provide? (July 21, 2017). Available at SSRN: https://ssrn.com/abstract=1956608 or http://dx.doi.org/10.2139/ssrn.1956608

Zhaohui Chen

University of Virginia - McIntire School of Commerce ( email )

P.O. Box 400173
Charlottesville, VA 22904-4173
United States
434-243-1188 (Phone)

Yan Hu (Contact Author)

University of La Verne ( email )

1950 Third Street
La Verne, CA 91750
United States

Kose John

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0337 (Phone)
212-995-4233 (Fax)

Connie X. Mao

Temple University - Fox School of Business and Management ( email )

416 Alter Hall
Philadelphia, PA 19122
United States
215-204-4895 (Phone)
215-204-1697 (Fax)

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