DP10252 The Transmission of Liquidity Shocks: Evidence from Credit Rating Downgrades

Author(s): Philippe Karam, Ouarda Merrouche, Moez Souissi, Rima Turk
Publication Date: November 2014
Keyword(s): credit ratings, credit supply, internal capital markets, liquidity management, multinational banks
JEL(s): E51, F23, F34, F36, G21
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=10252

We analyze the transmission of bank-specific liquidity shocks triggered by a credit rating downgrade through the lending channel. Using bank-level data for US Bank Holding Companies, we find that a credit rating downgrade is associated with an immediate and persistent decline in access to non-core deposits and wholesale funding, especially during the global financial crisis. This translates into a reduction in lending to households and non-financial corporates at home and abroad. The effect on domestic lending, however, is mitigated when banks (i) hold a larger buffer of liquid assets, (ii) diversify away from rating-sensitive sources of funding, and (iii) activate internal liquidity support measures. Foreign lending is significantly reduced during a crisis at home only for subsidiaries with weak funding self-sufficiency.