BANK-LENDING CHANNEL AND NON-FINANCIAL FIRMS: EVIDENCE FOR SPAIN
Santiago Carbó Valverde♣ (Universidad de Granada and Federal Reserve Bank of Chicago) Departamento de Teoría e Historia Económica. Facultad de Ciencias Económicas y Empresariales. Universidad de Granada. Campus Universitario de Cartuja s/n. E-18071 Granada Tel: +34 958243717 E-mail:
[email protected]
Rafael López del Paso Departamento de Teoría e Historia Económica. Facultad de Ciencias Económicas y Empresariales. Universidad de Granada. Campus Universitario de Cartuja s/n. E-18071 Granada Tel: +34 958243717 E-mail:
[email protected]
♣
Corresponding author
Acknowledgements: Financial support from MEC-FEDER, SEJ2005-04927 are acknowledged and appreciated by the authors. Santiago Carbó also acknowledges financial support from Junta de Andalucia, SEJ 693 (Excellence Groups). The views in this paper are those of the authors and may not represent the views of the Federal Reserve Bank of Chicago or the Federal Reserve System.
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Abstract: During the 1990s, liquidity was relatively abundant in the European Union and the European central banks mostly developed a relaxed monetary policy. While the bank lending channel view of the monetary policy would have suggested an increase in loans to firms in this context, the demand for bank corporate lending, however, slowed down, suggesting that monetary policy was not effective in this area. This article analyses how the financing behaviour of Spanish firms during 19922003 is related to their liquidity holdings and how this relationship may affect the effectiveness of the bank lending channel. The empirical evidence provided suggests that firms holding high liquid assets may replace bank lending by other sources of financing. Hence, higher liquidity holdings allow firms to invest in attractive investment projects in the event of a tightening of monetary conditions. (135 words)
Key words: monetary policy transmission, liquidity, firms.
JEL Codes: E51, G21, D21.
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1. Introduction During the 1990s, liquidity was relatively abundant in the European Union and the European central banks mostly developed a relaxed monetary policy. However, the demand for bank corporate lending unexpectedly slowed down, suggesting that monetary policy actions in this area were not completely effective. If bank credit is abundant and cheap, why do firms would rather use their liquidity or other non-bank financing such as trade credit?1 While the main argument of the so-called “bank-lending channel” is that a relaxed monetary policy induces banks to provide more lending, this did not seem to happen during this period. There is empirical evidence indicating that financial institutions with a higher proportion of liquid assets exhibit greater capacity to maintain the level of their credit investments in the event of a hardening of monetary conditions and they do not need to rely on other alternative sources of finance (Kashyap and Stein, 2000). Loupias et al. (2001) have also explored these relationships for European banking over the period 1993-2000 and find that bank lending decreases after a monetary policy tightening, although banks’ liquidity appears to affect significantly the lending behaviour. In the case of non-financial firms, however, there is very limited empirical evidence that these effects of liquidity may alter their financing decisions, particularly in Europe.
This article aims to analyze the relationship between the financing behaviour of firms and their liquidity holdings and the effects of this relationship on the effectiveness of monetary policy. The nature of these decisions should not be trivial for policymakers, central banks, banking institutions and non-financial firms in the context of the European financial integration and the single European monetary policy. It should be also taken into account that European firms rely more heavily on bank loans than their US counterparts.
This study aims to contribute to the existing literature by offering new empirical evidence on the effects of monetary policy on firm financial structure. We employ Spain as the laboratory for this
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Trade credit arises when a supplier allows a customer to delay payment for goods already delivered. In general, it is associated with the purchase of intermediate goods (Cuñat, 2007). 3
exercise. The Spanish case is a particularly interesting laboratory for two main reasons: 1) the 95 percent of Spanish firms are SME and they represent more than the 65 percent of total employment. These firms also depend critically on bank credit to undertake their investment projects and they have a very limited access to capital markets; 2) during the sample period (1992-2003) there has been a considerable reduction in the opportunity costs of maintaining liquid assets, as a consequence of a substantial reduction of interest rates.
The study is organized as follows. Section 2 surveys the existing literature. The empirical methodology is described in section 3. The main empirical goal is to analyze how the changes in the structure of firm external finance are related to monetary policy conditions during 1992-2003. Several structural and non-structural characteristics are considered as control variables. Section 4 shows the main empirical results. The study ends with a summary of the main conclusions and policy implications in section 5.
2. Firm financing and monetary policy conditions: background According to Modigliani and Miller (1958) –under the assumption of perfect markets and information– the market value of a firm is independent of its financial structure. Investment decisions would then depend only on the expected rate of return. In this context, it is indifferent to firms whether to use their own capital or to obtain external finance in order to carry out their investment projects. Likewise, the distinction between bank debt and non-bank debt would not be relevant, as the providers of both types of funding face the same supply conditions.
The empirical evidence shows that the perfect information model does not fit with the reality of firms (Kashyap et al., 1994; Bernanke et al., 1996). In the presence of asymmetric information, and given the non-perfect substitutive character of the different sources of finance, firms exhibit the following order of preferences within the available alternatives of funding: own funds, trade credit, capital markets financing and bank credit (Myers and Majluf, 1984; Calomiris and Hubbard, 1990). The way in which this structure is materialised determines the composition of the balance sheet, as
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well as the external finance premium, borne because of the cost assumed in the valuation of the collateral offered, as well as the control carried out during the period in which a debtor position is maintained (Stiglitz and Weiss, 1981).
Most of the previous studies have widely analysed the effects of monetary policy on the volume of credit in the economy (Bernanke and Blinder, 1992; Bernanke and Gertler, 1995; Kashyap and Stein, 2000). Most of them, however, have only tangentially focused on the reaction of firms to changes in monetary policy. An exception is Kashyap et al. (1993). This study shows that while a monetary contraction reduces bank lending, it increases commercial paper volume. This finding suggests that monetary tightening conditions lead to an inward shift in loan supply, rather than an inward shift in loan demand. However, it is also plausible that there is a “compositional shift” in play, with large firms demanding more credit than small firms. Since most commercial paper is issued by large firms, this could explain the Kashyap et al. (1993) results.
Similarly, Kashyap and Stein (2000) show that tight money should pose a special problem for small firms, which are more likely to be bank-dependent. Therefore, contractions in policy intensify liquidity constraints in the inventory and negatively affect the investment decisions of small firms. While this is consistent with the lending view, there is another interpretation in what Bemanke and Gertler (1995) called the "balance sheet channel," whereby tight monetary policy weakens the creditworthiness of small firms, and hence reduces their ability to raise funds from any external provider, not just banks. Given the relevance of information asymmetries in the process of credit supply (from any lender the firm can interact with), the theory of the balance sheet channel establishes that transformations in the structure of firms’ balance sheets –originated by the propagation of the economic cycle– may alter their capacity to obtain and spend resources, leading to the generation of endogenous credit cycles (Kiyotaki and Moore, 1997; Braun and Larrain, 2005). In this context, it is firms’ financial wealth which determines their access to financing, since financial wealth acts as collateral for the possible non-repayment of the capital contributed (Gertler, 1988). Even the strand of
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research that focuses on the bank lending channel indirectly assumes that firm characteristics such as financial wealth, financial debt, and some other structural financial characteristics (i.e. level of capital and liquidity), determine the degree of access to bank credit. This is likely to occur, in particular, when credit supply shrinks following a tightening of monetary conditions (Kashyap and Stein, 1995; Stein, 1998; Kishan and Opiela, 2000; Atanasova and Wilson, 2004). Consequently, it is expected that smaller firms and those with a lower level of capital will be affected to a larger extent by a contractive disturbance of monetary policy (Kashyap et al., 1993).
Firms of larger size present less severe problems of moral hazard and adverse selection because of their a priori greater transparency. This is perceived by the markets, so that they have a greater capacity to obtain external financing and to replace bank credit by other types of financing (at least compared to small firms) when interest rates rise (Hubbard, 1998). Likewise, those firms with greater own capital strength will display a greater capacity to carry out their investment projects (Baccheta and Caminal, 2000). Consequently, it is relatively frequent to observe that the bank lending channel operate in a similar fashion for both financial and non-financial firms when these two criteria are explicitly considered.
A different conclusion, however, is obtained when the analysis considers the role of firm liquidity holdings. On the one hand, there is empirical evidence that suggests that the holding of liquid assets above a certain threshold limits the possibilities of obtaining external funding resources, since it decreases the possibilities of assets portfolio transformation as well as the net value of the firm and the collateral that can be offered (Morellec, 2001). On the other hand, other studies maintain that firms with a substantial cushion of liquidity are better placed to grant and obtain finance from other firms in the economy, especially when there have been successive falls in interest rates. The effect of liquidity may well then explain why both the bank-lending channel and the balance-sheet channel prediction of a reduction in lending to firms with a tightening of monetary conditions may not always occur in practice. A recent study by Den Haan, Sumner and Yamashiro (2008) shows that real estate and
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consumer loans sharply decreased following a monetary tightening, while commercial and industrial loans increased. These responses, together with the responses of relevant lending rates, are hard to reconcile with a decline in the supply of commercial and industrial bank loans during a monetary downturn as stressed by the bank-lending channel. It is possible that liquidity and portfolio considerations imply that the supply of commercial and industrial loans actually increases following a monetary tightening. Even Bernanke and Gertler (1995) find that the most rapid and (in percentage terms, by far the strongest) effect of a monetary policy shock is on residential investment, whereas business structure investment, also a long-lived investment, does not seem to be much affected.
Trade credit between firms is a relevant variable in this context and it may also explain why the theoretical predictions on the bank lending channel are not empirically found in many studies. Overall, trade credit may affect the role of bank financing, in particular when firms’ liquidity holdings are high and when firms do not get the bank loans they desire. Wilner (2000) suggests that in case of renegotiation of debts, suppliers give more concessions to customers than banks do.2 Cuñat (2007) shows that trade credit seems to be more prevalent when firms have low levels of liquidity; in particular, the levels of trade credit are higher when firms experience liquidity shocks and justifies the existence of trade credit on the basis of suppliers being able to enforce debt repayment better than banks. This extra enforceability power comes from the link that makes both suppliers and customers costly to substitute.
Together with firm liquidity, the banks’ attitudes toward risk in a context of low interest rates may also explain the lack of explanatory power of the bank lending channel in certain situations. Jiménez et al. (2007) suggest that bank risk-taking increases when interest rates are lower prior to loan origination and that in this way monetary policy affects the composition of credit in the economy (i.e., the quality distribution of borrowers in the banks’ loan portfolios). They also suggest that lower 2
Frank and Maksimovic (2004) also explain the existence of trade credit as the result of suppliers having an advantage in liquidating intermediate goods in case of default by their buyers, given that they have specialized distribution channels to achieve this goal. These studies suggest that suppliers may then specialize in financing buyers with low creditworthiness, for whom liquidation is more likely to occur and may act also as liquidity providers, insuring against liquidity shocks that could endanger the survival of their customer relationships. 7
interest rates prior to loan origination result in banks granting loans with higher credit risk, but also that banks soften their lending standards and they lend more to borrowers with a bad credit history and with higher uncertainty. Matsuyama (2007), for example, shows that an increase of the borrowers’ net worth (e.g. through a decrease in interest rates) reduces agency costs thus making financiers more willing to lend to riskier borrowers (with less access to pledgeable assets). Low borrowers’ net worth, on the other hand, may impel financiers to flee to quality (Bernanke et al., 1996). Low interest rates may also abate adverse selection problems in the credit markets, causing banks to relax their lending standards and increase their risk-taking (Dell'Ariccia and Marquez, 2006). In general, low interest rates make riskless assets less attractive for financial institutions increasing their demand for riskier assets with higher expected returns (Rajan, 2006).
3. Empirical methodology and data 3.1. Specification and definition of variables Our empirical model relies on the standard theoretical framework of the bank lending channel formalized by Kashyap et al. (1993). In this model, a firm selects an optimal mix of bank debt (B) and non-bank debt (D) and seeks to minimize the financial cost. With MP denoting the stance of monetary policy and differentiating the structure of external finance (B/D) with respect to MP yields:
∂ (rB − rN ) ∂ ( B / D) 1 = ∂MP f ''( B / D ) ∂MP
(1)
This main result of the Kashyap et al. (1993) model shows that the optimal structure of external finance (B/D) moves inversely with the spread between bank loan rates (rB) and non-bank debt rates (rN). A tightening of monetary conditions in this framework is then expected to reduce the supply of bank loans relative to non-bank loans. The f in (1) shows the relationship benefit that a firm derives from bank borrowing and it is an increasing concave function (f’>0 and f’’
