Do banks propagate debt market shocks?

Do banks propagate debt market shocks? Purpose – This paper aims to analyze how banks transmit shocks that hit the debt market to their borrowers. Recent financial crisis demonstrated that the banking system can be a pathway for shock transmission. Design/methodology/approach – Bank‐level panel regressions. Findings – This paper shows that when banks experience a shock to the cost of their bond financing, they pass a portion of their extra costs or savings to their corporate borrowers. While banks do not offer special protection from bond market shocks to their relationship borrowers, they also do not treat all of them equally. Relationship borrowers that are not bank‐dependent are the least exposed to bond market shocks via their bank loans. In contrast, banks pass the highest portion of the increase in their cost of bond financing to their relationship borrowers that rely exclusively on banks for external funding. Research limitations/implications – These findings show that banks put more weight on the informational advantage they have over their relationship borrowers than on the prospects of future business with these borrowers. They also show a potential side effect of the recent proposals to require banks to use CoCos or other long‐term funding. Originality/value – The findings are timely, given the ongoing debates on the proposals to introduce bail‐in programs and proposals to require banks to use CoCos or other long‐term funding. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Financial Economic Policy Emerald Publishing

Do banks propagate debt market shocks?

Journal of Financial Economic Policy, Volume 6 (3): 41 – Jul 29, 2014

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Publisher
Emerald Publishing
Copyright
Copyright © 2014 Emerald Group Publishing Limited. All rights reserved.
ISSN
1757-6385
DOI
10.1108/JFEP-03-2014-0023
Publisher site
See Article on Publisher Site

Abstract

Purpose – This paper aims to analyze how banks transmit shocks that hit the debt market to their borrowers. Recent financial crisis demonstrated that the banking system can be a pathway for shock transmission. Design/methodology/approach – Bank‐level panel regressions. Findings – This paper shows that when banks experience a shock to the cost of their bond financing, they pass a portion of their extra costs or savings to their corporate borrowers. While banks do not offer special protection from bond market shocks to their relationship borrowers, they also do not treat all of them equally. Relationship borrowers that are not bank‐dependent are the least exposed to bond market shocks via their bank loans. In contrast, banks pass the highest portion of the increase in their cost of bond financing to their relationship borrowers that rely exclusively on banks for external funding. Research limitations/implications – These findings show that banks put more weight on the informational advantage they have over their relationship borrowers than on the prospects of future business with these borrowers. They also show a potential side effect of the recent proposals to require banks to use CoCos or other long‐term funding. Originality/value – The findings are timely, given the ongoing debates on the proposals to introduce bail‐in programs and proposals to require banks to use CoCos or other long‐term funding.

Journal

Journal of Financial Economic PolicyEmerald Publishing

Published: Jul 29, 2014

Keywords: Banks; Debt; Credit; Bank subordinate debt; Bond spreads; Lending channel; Loan spreads; E51, G21, G32

References

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