Bank Loans for Private and Public Firms in a Liquidity Crunch

Abstract: Bank reliance on short-term funding has increased over time. While an effective source of financing in good times, the 2007 financial crisis has exposed the vulnerability of banks and ultimately firms to such a liability structure. We show that banks dependent on wholesale funding contracted their lending the greatest during the crisis. Our results suggest, however, that in the financial crisis vulnerable banks passed the liquidity shock only to public firms and not to private firms. Loans to private firms were affected through a different channel, largely through higher retained shares by lead arrangers. Consistent with standard models of financial intermediation with information asymmetry, vulnerable banks increased their monitoring of informationally opaque firms for which the potential for informational rents is the highest.