- 0.0.1 Notes: This figure shows the fraction of banks reporting that they tightened lending standards on commercial and industrial loans to large or small firms during 2020 by size of exposure to credit line drawdown risk (denoted CLE; high CLE is above-mean drawdown risk and low CLE is below-mean drawdown risk). Source: Senior Loan Officer Opinion Survey of the U.S. Federal Reserve Board, Refinitiv Dealscan, Call Report.
- 1 What Is the Mechanism That Ties Credit Line Drawdowns to Bank Lending?
- 2 Policy Implications
Notes: This figure shows the fraction of banks reporting that they tightened lending standards on commercial and industrial loans to large or small firms during 2020 by size of exposure to credit line drawdown risk (denoted CLE; high CLE is above-mean drawdown risk and low CLE is below-mean drawdown risk).
Source: Senior Loan Officer Opinion Survey of the U.S. Federal Reserve Board, Refinitiv Dealscan, Call Report.
What Is the Mechanism That Ties Credit Line Drawdowns to Bank Lending?
We look for evidence on the friction behind our results by examining banks’ survey responses on their motivations to tighten lending standards from the 2020 SLOOS. This evidence highlights an important role for changes in risk tolerance at banks during the pandemic. A key result and unique contribution of our paper is to show that banks with larger exposures to drawdown risk were more likely to cite “lower risk tolerance” as an important reason for tightening lending standards, controlling for balance sheet characteristics and shifts in loan demand. By contrast, concerns over the banks’ own liquidity and capital positions were only weakly related to their ability to grant loans in 2020, suggesting that balance sheet constraints are not the key friction driving our results. Instead, the key mechanism appears to be the rise in risk aversion associated with the unexpected surge in drawdowns, which brought to the fore banks’ dormant off-balance sheet risks.
Our results highlight the tension that can arise during crises between banks’ role as “lenders of first resort” (Li et al. 2020) and their fundamental function of supplying credit, with implications for monetary policy and financial stability. First, banks’ exposure to pre-committed credit restrains financial intermediation after unexpected surges in drawdowns, even when balance sheets are strong, which can hamper monetary policy transmission. Second, a prudential metric of the Basel 3 regulatory framework—the liquidity coverage ratio (LCR)—needs to be revisited. In particular, given the high credit line utilization rates in spring 2020—especially in sectors severely hit by the pandemic—the assumption regarding the “stressed scenario” drawdown rate used in the LCR may need to be raised from the current 10% to a more realistic 20%–30%.
The views expressed in this article are ours and do not reflect those of the staff, management, or policies of the International Monetary Fund or the Federal Reserve System.
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Source : blogs.worldbank.org