Bank Loans for Private and Public Firms in a Credit Crunch

Abstract

Banks reliance on short-term funding has increased over time. While an effective source of financing in good times, the 2007 financial crisis has exposed the vulnerability of banks and ultimately firms to such a liability structure. We show that it was the banks that relied most on wholesale funding that contracted their lending the greatest during the crisis. Our results suggest, however, that banks propagate liquidity shocks by reducing credit only to a certain type of borrowers. Importantly, in the financial crisis banks passed the liquidity shock only to public firms and not to private firms. Loans to private firms were affected through a different channel, largely through higher retained shares by lead arrangers. Vulnerable banks increased their monitoring of informationally opaque firms for which the potential for informational rents is the highest.