Working Paper: NBER ID: w9956
Authors: Evan Gatev; Philip E. Strahan
Abstract: This paper argues that banks have a unique ability to hedge against market-wide liquidity shocks. Deposit inflows provide funding for loan demand shocks that follow declines in market liquidity. Consequently, one dimension of bank specialness' is that banks can insure firms against systematic declines in market liquidity at lower cost than other financial institutions. We provide supporting empirical evidence from the commercial paper (CP) market. When market liquidity dries up and CP spreads increase, banks experience funding inflows. These flows allow banks to meet increased loan demand from borrowers drawing funds from pre-existing commercial paper backup lines, without running down their holdings of liquid assets. Moreover, the supply of cheap funds is sufficiently large so that pricing on new lines of credit actually falls as market spreads widen.
Keywords: liquidity risk; commercial paper market; banks
JEL Codes: G2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| banks' funding dynamics (G21) | banks can insure firms against systematic declines in market liquidity (G33) |
| deposit inflows (F21) | hedge against loan demand shocks (E44) |
| market liquidity declines (G10) | funding inflows (F21) |
| funding inflows (F21) | meet increased loan demand (E51) |
| commercial paper spreads increase (E43) | banks experience inflows (G21) |
| supply of cheap funds from banks increases (G21) | lower pricing on new lines of credit (G21) |
| pricing of loan commitments (G21) | negatively correlated with covariance between funding costs and market liquidity availability (G19) |
| bank asset growth (G21) | increases in response to widening spreads in the commercial paper market (E44) |