Working Paper: NBER ID: w28559
Authors: Viral V. Acharya; Robert F. Engle III; Maximilian Jager; Sascha Steffen
Abstract: A two-sided "credit-line channel" – relating to drawdowns and repayments – explains the severe drop and partial subsequent recovery in bank stock prices during the COVID-19 pandemic. Banks with greater exposure to undrawn credit lines saw larger stock price declines but performed better before the pandemic and after the policy interventions. Despite deposit inflows, high drawdowns led to reduced bank lending, suggestive of capital encumbrance upon drawdowns. Repayments of credit lines unencumbered capital which explains the stock price recovery starting Q2 2020. Bank provision of credit lines resembles writing deep out-of-the-money put options on aggregate risk, and we propose how to incorporate this feature into bank capital stress tests.
Keywords: Bank stocks; COVID-19; Credit lines; Liquidity risk; Financial stability
JEL Codes: G01; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| higher exposure to undrawn credit lines (F65) | larger stock price declines (G19) |
| drawdowns of credit lines (G21) | locked up bank capital (G28) |
| locked up bank capital (G28) | prevented banks from engaging in potentially more lucrative lending opportunities (G21) |
| repayments of credit lines (G21) | recovery in stock prices (G10) |
| high gross drawdowns (G19) | reduced lending (G21) |
| low drawdowns (G19) | less reduction in lending (G21) |