Liquidity Insurance vs. Credit Provision: Evidence from the COVID-19 Crisis

Abstract

We study the link between the unexpected surge in credit line drawdowns in March-April 2020 and banks’ subsequent lending decisions. We find that banks with larger ex ante credit line portfolios, thus higher risk of drawdowns, tightened loan supply and the terms on new loans, especially to small firms. Exposed banks were also more reluctant to participate in the Paycheck Protection Program. The main mechanism was a reduction of risk tolerance rather than immediate balance sheet constraints. Our findings highlight the tension between banks providing liquidity insurance through precommitted credit while simultaneously sustaining lending to the broader economy during crises.

Keywords: corporate credit line drawdowns, off balance sheet exposures, bank loans, Paycheck Protection Program, COVID-19

JEL Classification: G21, E52, E58, E63