Opinion

Are Bank Credit Lines the New Source of Financial Fragility?

Viral Acharya

By Viral Acharya and Sascha Steffen

By Viral Acharya and Sascha Steffen

After the global financial crisis (GFC) of 2007-09, it was widely believed that the main source of stress for banks had been short-term wholesale funding. As banks struggled to meet short-term finance raised in shadow-banking markets, they passed on stress to the real economy. Post-crisis bank regulation, therefore, has focused on ensuring banks have access to sufficient liquidity to meet wholesale-funding needs.

Bank regulation, however, continues to suffer from the whack-a-mole problem. Wholesale funding relative to total assets has been halved since the GFC. Almost unnoticed has been the emergence of a new source of banking stress: drawdowns on credit lines, which are commitments by banks to issue new loans to firms on demand and according to pre-determined conditions. Banks receive fees in good times while providing these commitments but must honor them when drawn and, importantly, hold substantially higher capital against them thereafter.

Figure 1 shows the rise of credit-line commitments to US publicly listed firms since the GFC. These increased from 0.7 percent of gross domestic product (GDP) in 2009 to 5.7 percent of GDP in 2019. At the end of 2019, banks had committed to issuing about US$1.2 trillion in loans to the US publicly listed firms alone—excluding their commitments made alongside high-risk leveraged buyout (LBO) transactions, since these firms are mostly private. Bond-market financing, at the same time, increased to more than 20 percent of GDP, while bank term lending declined.

Read the full International Banker article.

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Viral Acharya is the C.V. Starr Professor of Economics