Credit Crunches from Occasionally Binding Bank Borrowing Constraints

45 Pages Posted: 11 Feb 2019 Last revised: 1 Mar 2019

See all articles by Tom Holden

Tom Holden

University of Surrey - School of Economics

Paul Levine

School of Economics, University of Surrey

Jonathan M. Swarbrick

Government of Canada - Bank of Canada

Date Written: 2018

Abstract

We present a model in which banks and other financial intermediaries face both occasionally binding borrowing constraints, and costs of equity issuance. Near the steady state, these intermediaries can raise equity finance at no cost through retained earnings. However, even moderately large shocks cause their borrowing constraints to bind, leading to contractions in credit offered to firms, and requiring the intermediaries to raise further funds by paying the cost to issue equity. This leads to the occasional sharp increases in interest spreads and the counter-cyclical, positively skewed equity issuance that are characteristic of the credit crunches observed in the data.

Keywords: Occasionally binding constraints, Credit crunches, Financial crises, Spreads, Dividends, Equity, Banking

JEL Classification: E22, E32, E51, G2

Suggested Citation

Holden, Tom and Levine, Paul L. and Swarbrick, Jonathan M., Credit Crunches from Occasionally Binding Bank Borrowing Constraints (2018). Deutsche Bundesbank Discussion Paper No. 57/2018. Available at SSRN: https://ssrn.com/abstract=3331452

Tom Holden (Contact Author)

University of Surrey - School of Economics ( email )

Guildford
Guildford, Surrey GU2 5XH
United Kingdom

HOME PAGE: http://www.tholden.org/

Paul L. Levine

School of Economics, University of Surrey ( email )

Guildford
Surrey GU2 7XH
United Kingdom
+44 1483 259 380 Ext. 2773 (Phone)
+44 1483 259 548 (Fax)

Jonathan M. Swarbrick

Government of Canada - Bank of Canada

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

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