Bank Lines of Credit as Contingent Liquidity: A Study of Covenant Violations and Their Implications

42 Pages Posted: 2 Aug 2014

See all articles by Viral V. Acharya

Viral V. Acharya

New York University - Leonard N. Stern School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); New York University (NYU) - Department of Finance

Heitor Almeida

University of Illinois at Urbana-Champaign; National Bureau of Economic Research (NBER)

Filippo Ippolito

Universitat Pompeu Fabra - Faculty of Economic and Business Sciences; Barcelona Graduate School of Economics; Centre for Economic Policy Research (CEPR)

Ander Perez-Orive

Federal Reserve Board

Date Written: July 9, 2014

Abstract

We study how the consequences of violations of covenants associated with bank lines of credit to firms vary with the financial health of lenders. Following a violation banks restrict usage of lines of credit by raising spreads, shortening maturities, tightening covenants, or cancelling the line or reducing its size. Even though the frequency of covenant violations is fairly stable during the period 2002-2011, the reaction of banks to violations became significantly more restrictive during the recent crisis. Banks in worse financial health are more likely to restrict access to credit lines following a violation, and violations driven by lender health have capital structure and real implications for firms. This behavior is at the heart of a new bank liquidity channel. This channel complements the traditional bank lending channel, which focuses on small financially constrained firms, because credit lines are commonly used by large, high credit quality firms to provide insurance against loss of access to external finance.

Keywords: lines of credit, firm financial constraints, bank financial health, covenant violations

JEL Classification: G21, G31, G32, E22, E5

Suggested Citation

Acharya, Viral V. and Almeida, Heitor and Ippolito, Filippo and Perez-Orive, Ander, Bank Lines of Credit as Contingent Liquidity: A Study of Covenant Violations and Their Implications (July 9, 2014). ECB Working Paper No. 1702. Available at SSRN: https://ssrn.com/abstract=2464110

Viral V. Acharya

New York University - Leonard N. Stern School of Business ( email )

44 West 4th Street
Suite 9-160
New York, NY NY 10012
United States

HOME PAGE: http://pages.stern.nyu.edu/~sternfin/vacharya/public_html/~vacharya.htm

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

New York University (NYU) - Department of Finance

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Heitor Almeida

University of Illinois at Urbana-Champaign ( email )

515 East Gregory Drive
4037 BIF
Champaign, IL 61820
United States
217-3332704 (Phone)

HOME PAGE: http://www.business.illinois.edu/FacultyProfile/faculty_profile.aspx?ID=11357

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Filippo Ippolito

Universitat Pompeu Fabra - Faculty of Economic and Business Sciences ( email )

Ramon Trias Fargas 25-27
Barcelona, 08005
Spain
(+34) 93 542 2578 (Phone)
(+34) 93 542 1746 (Fax)

Barcelona Graduate School of Economics ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Ander Perez-Orive (Contact Author)

Federal Reserve Board ( email )

20th and C Streets, NW
Washington, DC 20551
United States

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