European firms, Panic Borrowing and Credit Lines Drawdowns: What did we learn from the COVID-19 Shock? (With Mario Cerrato and Shengfeng Mei, online appendix, submitted manuscript)
Abstract: We show that European firms, at the peak of the COVID-19 shock in 2020:Q2, went into a “panic borrowing” status and drew down 87bn euros in a very short period. We show that firms with less stringent solvency and liquidity constraints drew down their credit lines and accumulated cash. Our study exploits the implications of the social distancing policies to corporate operations across Europe. It proposes a novel empirical framework that identifies panic borrowing while accounting for the endogeneity between credit line drawdowns and an underlying borrowing ability during the COVID-19 shock. We use COVID-19 infection data and proxies for social distancing policies in Europe to study if the increase in risk following the COVID-19 shock can explain the panic borrowing while accounting for possible endogenous credit lines drawdowns. Finally, we show that European corporate drawdowns during the pandemic crisis increased drawdowns, on average, by 3.35 percentage points in response to an unexpected one percentage point fall in their cash flows but only when firms’ earnings are negative. This result is driven by the lockdown policies introduced in Europe.
The diagram shows the estimated cross-sectional differential percentage point changes in the drawdown to total assets ratio given a one percentage point change in the EBITDA to total assets ratio during the pandemic. Each cross-sectional difference evaluates the corresponding shift in draw down decisions across the pairwise above- versus below-threshold value. The horizontal axis shows several bandwidth selections proportional to the standard deviation of the empirical distribution summarising EBITDA observations. Each value computed on the vertical axis is evaluated based on a separate estimation with an associated 95% confidence interval. The bandwidth selections considers even intervals around zero-earnings and shows a sharp shift in the firms’ behaviours to draw down credit lines when facing marginally negative earnings while exhibiting no particular decision when facing marginally positive earnings.
Abstract: I show that when the banking sector's assets comprise large excess reserves and loans, jointly determined capital regulation and interest-on-excess-reserves (IOER) policies provide welfare gains. In general equilibrium, falling IOER is associated with a proportional fall in deposit rate only when IOER is above the zero bound. This leads to a faster fall in the bank's interest expenses than its interest incomes. Given any lending level, lower net interest expenses enhance bank solvency. Nonetheless, the risk-weighted capital regulation remains unchanged and hence becomes socially costly. I show that jointly determined policies achieve welfare gains by loosening the capital requirement and lowering IOER to expand the credit flow, while bank failure likelihood remains constant. Conversely, lowering IOER below the zero bound is associated with a nonresponsive deposit rate that leads to growing net interest expenses and worsening bank solvency. In that case, I show that a stricter capital constraint together with a lower IOER provide social value.
The social welfare increases towards the inner contour curves depicted by dashed (blue), dashed-dotted (orange) and solid (red) contours. The horizontal solid line describes the RW-capital regulation (I) that is decided in isolation of interest rate policy which is always associated with a lower welfare, relative to RW-capital regulation (II). Regulatory schedule (II) considers the welfare implications of lower IOER and is less strict than (I) and is able to achieve higher welfare relative to (I).
Financial Regulation and Wealth Distribution
Abstract: Financial regulation provides welfare gains to the society, at the expense of an exacerbated wealth distribution. I show that when capital markets are segmented, financial regulation leads to a transfer of wealth from depositors to equity investors. An integrated monetary and financial regulatory policy achieves welfare gains due to a credit flow expansion to the real sector, while default likelihood within the banking sector remains fixed. Nonetheless, this constrained equilibrium allocation is associated with lower deposit rate while dividends increase, leading to a wealth transfer across market segments. I provide sufficient conditions under which optimal financial regulation leads to welfare gains without exacerbating wealth heterogeneity.
Pay Banks to Lend: Targeted Long-Term Refinancing Operations and the Fiscal Stimulus
Abstract: The aftermath of the financial crisis inherited heightened economic uncertainty and low productivity. These features prompted the banking sectors across the developed economies to rely heavily on excess reserves offered by the central banks despite the negative nominal interest-on-excess-reserve (IOER) policy. Nonetheless, the negative relationship between the overall interest expenses of the banking sector with the IOER around the zero lower bound further exacerbates the over-reliance on excess reserves particularly when rates are negative. This paper shows that the new Targeted Long-Term Refinancing Operations (TLTRO) policy adopted by the central banks leads to expansionary effects when the refinancing lending rates fall below the IOER. I first provide a social welfare maximizing approach to determine the optimal borrowing limit. Second, I show that the policymaker's decision to finance the deficit due to remunerations depends on the trade-offs between the social gains associated with the expansion of lending to the real sector against the social costs of monetary tools (creating money to finance the gap) the fiscal stimulus.
Joint Fiscal-Monetary Policy Responses to Transitory Aggregate Shocks
I show that unilateral fiscal and monetary interventions, in response to transitory aggregate shocks, lead to welfare losses when real interest rates are low or possibly negative. A hyperactive fiscal policy in the forms of increased transfers and suppressed taxation revenues relies heavily on sovereign borrowing to smooth out adverse economic downturns, while the monetary base rate falls excessively to lower cost of finance. In general equilibrium with a banking sector subject to aggregate uncertainty, the transmission mechanism from the monetary policy to the credit sector weakens leading to an exacerbated real economic stagnation and heightened intermediary insolvencies. I show that a joint fiscal-monetary policy that optimally trades off higher credit flows to the real sector against lower rates delivers welfare gains during the transition and long-term by lowering future taxations to settle fiscal borrowing.
Current PhD Candidates
Working on credit lines and empirical banking
Working on Trading Volume, Order Flow and Volatility in the Foreign Exchange Markets
Working on Central Counterparty Clearing