Loan to Bond Substitution: An Empirical Analysis on the Functioning of the Substitution Channel for Eurozone Firms

42 Pages Posted: 16 Feb 2018

Date Written: January 30, 2018


This work aims to provide new insights on the functioning of financial markets. In particular, I focus on European markets with the final objective of uncovering important evidences for the implementation of policies aimed to improve the resiliency of the financial system to economic crises.

The paper analyses firm's choice of funding and its relationship with the evolution of the credit cycle. Using a sample of U.S. and European firms, I document the existence of a credit substitution channel between loans and bonds that reduces the adverse effect of a shrink in credit supply. Moreover, I also report estimates on the degree of substitution. In particular, I investigate on the ability of firms to fully substitute between the two forms of debt, and I find that firms in Eurozone countries can only partially substitute bank debt with market debt.

The identification strategy I implement allows to untangle the effect of the demand and supply of credit fundamental in the analysis. In this work I find evidence that poor conditions in the banking sector negatively affects the supply of loans, and provides ground to advocate for the importance of the substitution channel in relaxing the adverse effects of a downturn. Furthermore I find that for variables less related to the actual “health” of the banking sector and more related to the mechanism underlying the choice of granting loans to firms (e.g. the measure of lending standards and the monetary policy stance), the substitution channel might work differently in Eurozone compared to the U.S.. Periods of tight lending standards are not necessarily related to a reduction in credit supply but could be the outcome of a different allocation of funds among bank borrowers.

Keywords: Banking, Corporate Finance, Loan substitution, Credit cycle, Lending condition

JEL Classification: G21, G32

Suggested Citation

Ruggiero, Francesco, Loan to Bond Substitution: An Empirical Analysis on the Functioning of the Substitution Channel for Eurozone Firms (January 30, 2018). Available at SSRN: or

Francesco Ruggiero (Contact Author)

University of Naples Federico II ( email )

via Cinthia, 21
Naples, Napoli 80126

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