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.

Last updated on 02/02/2018