TAILIEUCHUNG - CYCLICALITY OF CREDIT SUPPLY: FIRM LEVEL EVIDENCE

THE credit standing of an applicant for a personal loan is investigated intensively because it indicates, within reason- able limits, the likelihood of repayment. It should not be assumed, however, that a bank officer can foretell with cer- tainty how faithfully a borrower will meet his obligations; few applicants have economic prospects so bad that there is not some small chance of repayment, and few are so well sit- uated that there is not some possibility of delinquency or even default. The selection of borrowers must therefore rest on probabilities. On the basis of experience, and to some ex- tent intuition, the loan officer decides which applicants are more likely to. | CYCLICALITY OF CREDIT SUPPLY FIRM LEVEL EVIDENCE Bo Becker Harvard University and NBER Victoria Ivashina Harvard University and NBER First draft May 19 2010 This draft August 23 2011 Theory predicts that there is a close link between bank credit supply and the evolution of the business cycle. Yet fluctuations in bank-loan supply have been hard to quantify in the timeseries. While loan issuance falls in recessions it is not clear if this is due to demand or supply. We address this question by studying firms substitution between bank debt and non-bank debt public bonds using firm-level data. Any firm that raises new debt must have a positive demand for external funds. Conditional on issuance of new debt we interpret firm s switching from loans to bonds as a contraction in bank credit supply. We find strong evidence of substitution from loans to bonds at times characterized by tight lending standards high levels of non-performing loans and loan allowances low bank share prices and tight monetary policy. The bank-to-bond substitution can only be measured for firms with access to bond markets. However we show that this substitution behavior has strong predictive power for bank borrowing and investments by small out-of-sample firms. We consider and reject several alternative explanations of our findings. Key words Banks Financial Markets and the Macroeconomy Business Cycles Credit Cycles JEL Codes E32 E44 G21 We are grateful to Murillo Campello Erik Hurst Atif Mian Joe Peek Mitchell Petersen Amiyatosh Purnanandam Christina Romer David Romer Erik Stafford Jeremy Stein René Stulz Luis Viceira James Vickrey Vikrant Vig and seminar participants at the AFA 2011 meeting the EFA 2011 meeting Bank of Canada Bank of Spain Boston University Boston University Conference on Credit Markets DePaul City University of Hong Kong Harvard Business School Federal Reserve Bank of St. Louis European Central Bank Federal Reserve Board the London School of Economics the 3rd Paris Spring .

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