The credit line drawdown channel
In March 2020, at the onset of the pandemic, banks faced unprecedented aggregate demand for credit-line drawdowns. As a result, bank stock prices crashed. In this paper, Acharaya et al. identify the “credit line drawdown channel” as the reason for the crash, namely: stock prices of banks with large ex-ante exposures to undrawn credit lines as well as large ex-post gross drawdowns declined significantly more than non-financial stocks. Moreover, banks with large gross drawdowns reduced their immediate supply of term loans (not credit lines), while banks with less deposit inflows reduced credit line originations. The effect was attenuated for banks with higher capital buffers. These banks reduced term loan lending, even after policy measures were implemented. The authors add that this type of balance sheet liquidity risk was also present during the 2008 financial crisis with the main difference that during the pandemic it was due to the aggregate drawdown risk i.e. credit lines, while during the financial crisis it was due to aggregate rollover risk i.e wholesale finance.
A final key question is how can policy makers address aggregate drawdown risk in an ex-ante manner? One possible way is for regulators to add the effect of drawdowns to stress tests and require banks to fund these exposures with equity.
Why Did Bank Stocks Crash During COVID-19?
Authors: Viral V. Acharya, Robert F. Engle III, Sascha Steffen
From: New York University, Frankfurt School of Finance & Management
Incentives to banks to increase lending
In March 2020 the Fed established the Main Street Lending Program (MSLP), an innovative program aimed at facilitating the credit flow to small business affected by the pandemic. It was innovative because of its reliance on banks to screen and originate loans, the bulk of which could then be sold to a special purpose vehicle (SPV) maintained by the Fed. Unlike other programs that were implemented during the same period and with the same goal, MSLP loans were not grants and needed to be repaid while lenders were required to retain 5% risk exposure to the borrower.
In this paper, Minoiu et al. study the effects of the MSLP program on bank lending. Using a difference-in-differences approach, they find that MSLP lenders tightened lending standards and terms on new commercial and industrial (C&I) loans by less than non-lenders, were more likely to originate and renew C&I loans, and provided relatively better terms on approved loans (including lower spreads, longer maturities, and lower collateral requirements). MSLP participating banks also granted relatively more small business loans, especially to ex-ante safer borrowers, which were current on their debt payments and had higher credit scores. Why did banks participate in this program? It seems that MSLP may have alleviated bank balance sheet constraints and increased risk tolerance.
Motivating Banks to Lend? Credit Spillover Effects of the Main Street Lending Program
Authors: Camelia Minoiu, Rebecca Zarutskie, Andrei Zlate
From: Board of Governors of the Federal Reserve System
