Credit line exposures worsened Covid bank stock crash – NBER paper

Banks with greater exposures via undrawn credit lines suffered sharper stock price falls during the Covid-19 crisis, new research finds.

Authors Viral Acharya, Robert Engle and Sascha Steffen construct a new measure of banks’ balance-sheet liquidity risk, comprised of “undrawn commitments” and wholesale finance minus cash or cash equivalents.

“We show that our measure of the liquidity risk of banks is important to understand the decline of bank stock prices during the first phase of the pandemic,” they say in the National Bureau of Economic Research working paper.

The results imply the impact is “episodic”, affecting stock prices at times when multiple firms draw down their credit lines simultaneously. The authors focus on the Covid crisis, but they say similar effects were seen during the global financial crisis.

The authors argue this drawdown risk “does not appear to be captured in traditional measures of bank exposure or systemic risk”. They go on to estimate the capital shortfall that results from their measure of balance-sheet liquidity risk, and suggest a means of integrating this into stress-testing frameworks.