Bank Lending and Credit Supply Shocks

This paper analyzes the linkages between credit supply conditions and bank lending. Building on the recent work of Gilchrist and Zakraǰsek [2011], we use the excess bond premium—a component of corporate credit spreads designed to measure shifts in the risk attitudes of financial intermediaries—to empirically identify credit supply shocks. Our results indicate that shocks to the excess bond premium lead to a pronounced and protracted contraction in economic activity, a decline in nominal interest rates, a sharp fall in equity valuations, and an eventual decline in business loans outstanding. To shed light on the sluggish response of business lending to our measure of credit supply shocks, we examine the joint responses of business loans outstanding and corresponding unused commitments, an especially cyclically-sensitive component of bankintermediated business credit. According to our results, the lagged response of business loans to credit supply disruptions appears to be a typical feature of business cycles, because in the initial phase of the downturn, the capacity of businesses to borrow from the banking sector shrinks primarily through reductions in unused commitments and only eventually through a reduction in loans outstanding. Overall, our results indicate that once differences in responses of unused commitments and loans outstanding to credit disruptions are accounted for, the capacity of businesses to borrow from the commercial banking sector is highly sensitive to changes in credit supply conditions. JEL Classification: E44, E51, G21