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

44 Pages Posted: 27 Jan 2021 Last revised: 31 Jan 2021

See all articles by Tumer Kapan

Tumer Kapan

International Monetary Fund (IMF)

Camelia Minoiu

Board of Governors of the Federal Reserve System

Date Written: January 29, 2021

Abstract

We exploit the unexpected surge in corporate credit line drawdowns in the early phase of the COVID-19 pandemic as a bank balance sheet shock and examine the impact on banks’ lending decisions. We show that banks with larger ex-ante credit line portfolios---and hence higher risk of drawdowns---reported tightening lending standards on new C\&I loans to small and large firms, curtailed the supply of large syndicated loans, and reduced the number and volume of small business loans since March 2020. Exposed banks were also less likely to participate in and grant loans through government-sponsored credit programs such as the Paycheck Protection Program and the Main Street Lending Program. We document that the main mechanism by which the risk of credit line drawdowns likely affected banks' lending decisions was a reduction of risk tolerance rather than balance sheet (liquidity and capital) constraints. Our findings suggest that tension may arise during crises between banks providing liquidity insurance to firms through pre-committed credit lines while at the same time sustaining loan supply to the broader economy, with important implications for monetary policy and financial stability policies.

Keywords: corporate credit line drawdowns, bank lending, bank risk management, Paycheck Protection Program, Main Street Lending Program, COVID-19

JEL Classification: G21, E52, E58, E63

Suggested Citation

Kapan, Tumer and Minoiu, Camelia, Liquidity Insurance vs. Credit Provision: Evidence from the COVID-19 Crisis (January 29, 2021). Available at SSRN: https://ssrn.com/abstract=3773328 or http://dx.doi.org/10.2139/ssrn.3773328

Tumer Kapan

International Monetary Fund (IMF) ( email )

1700 19th Street, NW
Washington, DC 20431
United States

Camelia Minoiu (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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