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.
Bank-level panel regressions.
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.
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.
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.
The authors thank David Marqués, Evren Damar, Filipa Sá, Julio Rotemberg, Mark Flannery, and seminar participants at Tilburg University, Paris School of Economics, Federal Reserve Bank of San Francisco, Bank of Brazil, Bank of Canada workshop on Financial Institution Behaviors and Regulations, ECB conference “The bank lending channel in the euro area: New models and empirical analysis,” the 2010 University of Cambridge Conference on Networks, and the 2009 Gersenzee summer workshop for useful comments. The views stated herein are those of the authors and are not necessarily the views of the Federal Reserve Banks of San Francisco or New York, or the Federal Reserve System.
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