How Committed are Bank Corporate Line Commitments?
50 Pages Posted: 13 May 2012 Last revised: 2 Aug 2012
Date Written: May 13, 2012
Firms' liquidity needs increase when their financial condition deteriorates or when there is an aggregate credit crunch. Banks receive considerable revenue for providing liquidity support to firms via lines of credit but banks become exposed to credit risk when liquidity needs are related to deteriorating firm conditions. We examine how banks manage credit limits and line usage using an extensive longitudinal regulatory database on syndicated credit obtained by over 13,000 private and public firms, covering 1997-2009. We show that banks rarely limit access to existing credit lines until they rate firms as high risk or firms have already used much of their credit limit. Further, firms that get downgraded by banks are able to anticipate future constraints on line access, and draw on lines in advance of such restrictions. During a credit crunch, even higher risk firms draw on their existing lines of credit, if they have substantial unused capacity. These results suggest that lines of credit or revolvers provide considerable liquidity insurance. Our findings are similar across public and private firms, but we also find that private firms face larger limit cuts than public firms with the same bank internal rating. Our paper integrates the divergent strands in the literature on firm liquidity and lines of credit and re-affirms the importance of banks in liquidity provision.
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