Bank Lines of Credit as Contingent Liquidity: Covenant Violations and Their Implications
46 Pages Posted: 16 Oct 2017
Date Written: June 2016
We examine the relation between the financial health of banks and their willingness to supply capital to borrowers under previously committed credit lines. We show that during the collapse of the Asset Backed Commercial Paper market in the last quarter of 2007 and the first half of 2008, banks with higher exposure to conduits renegotiated significantly tougher conditions on the outstanding credit lines offered to borrowers in violation of a covenant. Looking at the broader period of the financial crisis (2007-2010), we find that a worsening in financial health at banks led to a lower probability of waivers, following a covenant violation on a credit line. Our paper suggests that a worsening in financial conditions of lenders can bear financial implications for firms that use credit lines as an instrument of liquidity management.
Keywords: Lines of Credit, Bank Financial Health, Covenant Violations
JEL Classification: G21, G31, G32, E22, E5
Suggested Citation: Suggested Citation