Cyclicality of Credit Supply

In the paper, Cyclicality of Credit Supply: Firm Level Evidence, which was recently made publicly available on SSRN, we study bank loan supply through the business cycle using firm level data from 1990 to 2009. It is well known that lending is cyclical. The contribution of our paper is to address two of the main empirical challenges in identifying whether this reflects the effects of bank credit supply. First, we focus on firms’ choice between two close forms of external debt financing: bank debt and public bonds. By conditioning the sample on firms raising new debt, we can rule out a demand explanation for the drop in bank borrowing which coincides with downturns. Second, by doing the analysis at the firm level, we can directly address how the composition of firms raising finance varies through time. This allows us to rule out compositional changes in the pool of firms seeking debt finance as an explanation of our findings.

Using a sample of U.S. firms for the period 1990-2009, we find strong evidence of substitution from bank loans to bonds at times characterized by tight lending standards, high levels of non-performing loans to bank equity, low bank share prices and tight monetary policy. To illustrate our point, in the last half of 2007, 36% of all debt issues were bank loans. However, the relative loan share fell to 8% by the first half of 2009, the lowest level in the period from 1990 to 2009. Although the bank-to-bond substitution can only be measured for larger firms (which have access to bond markets), we confirm that this substitution has strong predictive power for lending volume by small and unrated firms.

The full paper is available for download here.