The Loan Covenant Channel: How Bank Health Transmits to the Real Economy

57 Pages Posted: 2 Oct 2017

See all articles by Gabriel Chodorow-Reich

Gabriel Chodorow-Reich

Harvard University Department of Economics

Antonio Falato

Board of Governors of the Federal Reserve System

Date Written: September 2017

Abstract

We document the importance of covenant violations in transmitting bank health to nonfinancial firms using a new supervisory data set of bank loans. More than one-third of loans in our data breach a covenant during the 2008-09 period, providing lenders the opportunity to force a renegotiation of loan terms or to accelerate repayment of otherwise long-term credit. Lenders in worse health are less likely to grant a waiver and more likely to force a reduction in the loan commitment following a violation. Quantitatively, the reduction in credit to borrowers with long-term credit but who violate a covenant accounts for an 11% decline in the volume of loans and commitments outstanding during the 2008-09 crisis, a similar magnitude to the total contraction in credit during that period. We conclude that the transmission of bank health to nonfinancial firms occurs largely through the loan covenant channel.

Suggested Citation

Chodorow-Reich, Gabriel and Falato, Antonio, The Loan Covenant Channel: How Bank Health Transmits to the Real Economy (September 2017). NBER Working Paper No. w23879. Available at SSRN: https://ssrn.com/abstract=3046392

Gabriel Chodorow-Reich (Contact Author)

Harvard University Department of Economics ( email )

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HOME PAGE: http://scholar.harvard.edu/chodorow-reich

Antonio Falato

Board of Governors of the Federal Reserve System ( email )

20th & C. St., N.W.
Washington, DC 20551
United States

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