The Loan Covenant Channel: How Bank Health Transmits to the Real Economy

Citation:

Chodorow-Reich, Gabriel, and Antonio Falato. 2017. “The Loan Covenant Channel: How Bank Health Transmits to the Real Economy”.
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Abstract:

We document the importance of covenant violations in transmitting bank health to nonfinancial firms using a new supervisory data set of bank loans. More than one-third of loans in our data breach a covenant during the 2008-09 period, providing lenders the opportunity to force a renegotiation of loan terms or to accelerate repayment. Lenders in worse health are less likely to grant a waiver and more likely to force a
reduction in the loan commitment. Quantitatively, the reduction in credit to borrowers with long-term credit but who violate a covenant accounts for an 11\% decline in the volume of loans and commitments outstanding during the 2008-09 crisis, slightly larger than the total contraction in credit during that period. We conclude that the transmission of bank health to nonfinancial firms occurs largely through the loan covenant channel.

Notes:

Revise and resubmit, Journal of Finance
Last updated on 11/27/2018