EIB Working Papers 2019/07 - What firms don't like about bank loans: New evidence from survey data

European Investment Bank

• Publisher: European Investment Bank
• Year: 2019
• eBook ISBN: 9789286143588
• Topic: Economics
• Subtopic: Public Finance
• Index: Economics

We use the association between non-financial firms and their banks, an information available in the European Investment Bank Investment Survey (EIBIS), to disentangle the effects of borrowers' and lenders' financial weakness on the satisfaction with the loan contracted. The dataset matches survey data of non-financial firms about their satisfaction with bank lending with their financial data and the financial data of their banks. We find evidence of both demand and supply factors determining firm satisfaction with bank loan financing: non-financial firms with weaker finances and those financed by weaker banks are less satisfied with their bank financing. We also find that the impact of supply factors differs across regions within the EU: the effect of bank's financial weakness on borrower satisfaction is not significant in core countries but is in periphery countries.

1    Introduction

Conditions to access external finance are important determinants of firms’ investment policies. According to the European Investment Bank Investment Survey (EIBIS), in 2018, the average share of external finance in EU corporate investment expenditure is around 35%.² The financial crisis of 2008-9 and the subsequent sovereign debt crisis in Europe in 2010-12 provided a forceful reminder of the importance of external finance through the detrimental impact of credit supply shocks and borrowers’ balance sheet strength on investment and real activity (Jiménez et al. 2012, Iyer et al. 2014, Jiménez et al. 2017, Kalemli-Ozcan et al. 2018).

The main contribution of this paper is to estimate the relative importance of non-financial firms’ and their banks’ financial weakness on bank lending conditions using new data available from the EIBIS. Existing empirical evidence on this relationship is scarce given the necessity to have matched bank-firm data and information on access to credit conditions. The EIBIS, whose first wave was in 2016, provides such information for all Member States of the European Union. To the best of our knowledge, our paper is among the first to use qualitative information on bank financing conditions for non-financial firms and link it to financial characteristics of both non-financial firms and their respective banks.³ Indeed, compared to loan-level data traditionally used in this literature, the EIBIS allows to assess the difficulties of firms to access bank lending along several dimensions, including non-price terms of loans such as maturity and collateral requirements.

We build financial weakness indicators for non-financial firms and for the corresponding banks using their respective financial ratios. We then evaluate the relative impact of these indicators on firms’ satisfaction with their loan contracts. Using a simple econometric framework we attempt to disentangle the role of supply (lender) and demand (borrower) characteristics in explaining this satisfaction, which we measure with qualitative information from the EIBIS. We show evidence that, up to at least 2015 and 2016⁴ - eight years after the global financial crisis and four years after the sovereign debt crisis in Europe - banks’ financial conditions still exert negative effects on credit supply. Furthermore, the relative importance of banks’ and firms’ financial weakness differs across country groups.⁵ In core countries, firm’s financial weakness is the main determinant of satisfaction with bank finance. Bank’s financial position has virtually no statistically significant effects. This suggests that firms’ financing conditions are impacted by banks’ risk management practices rather than banks’ financial constraints. In periphery countries, corporates associated with banks with weaker financial conditions are significantly more likely to be dissatisfied with their financing conditions compared to core countries. Banks in periphery countries likely faced tighter financial constraints that impacted credit conditions. This is in line with the idea of a continuing effect of the financial fragmentation observed in Europe after the sovereign debt crisis. These results could also partly be explained by a higher capacity of firms to switch between banks in core countries compared to periphery countries. If firms are able to switch easily, we expect banks’ financial constraints to have a limited impact on credit conditions.⁶

The most important policy implication from our study is that strengthening the banking system is of utmost importance for access to finance and real activity in several countries and should be a policy priority. Our results are suggestive of a lasting effect of the European debt crisis in these areas. Our analysis also shows that financial weakness of firms remains a key determinant of satisfaction with credit conditions in both core and periphery countries.

The rest of the paper consists of four sections and concluding remarks. Section 2 reviews the literature. Section 3 describes the data. Section 4 details the empirical results. Robustness checks are presented in section 5. Section 6 concludes.

2 Related Literature

Small and transitory events may have large and persistent effects on the economy because of the presence of financial constraints on non-financial firms (Bernanke & Gertler 1989, Bernanke et al. 1996, Kiyotaki & Moore 1997). Effects are not only persistent but also amplify initial shocks through borrowers’ balance sheets and asset prices. This occurs because asymmetric information between borrowers and lenders generates agency costs that raise the cost of external finance and decrease borrowing limits. Their fluctuation over the business cycle reinforce the effects of the initial financial shock (Gilchrist & Zakrajšek 2012).

Holmstrom & Tirole (1997) argue that banks are also borrowers and are also subject to agency costs. Changes in their net worth or the market value of their assets can affect the non-financial sector through shifts in their supply of credit. Banks mitigate the agency problems with the amount of capital that they hold. Loss of capital that typically occurs during economic downturns, due to falling asset prices and deteriorating asset quality, means that banks limit loan supply in an attempt to preserve their capital base.⁷

Gertler & Kiyotaki (2010) combine credit constraints of non-financial borrowers and of financial intermediaries so that the net worth of both financial and non-financial companies has effects on availability of credit and on real activity. The authors find that the endogenous disruptions to financial intermediation substantially magnify economic downturns.

The liquidity squeeze following the financial crisis in 2008 (Ippolito et al. 2016, Iyer et al. 2014), low capital ratios (Jiménez et al. 2012, Acharya et al. 2018) and excessive exposure to debt securities issued by governments in financial distress (Acharya et al. 2018, Popov & Van Horen 2015) created an asymmetric transmission of the financial shock to the real economy as different banks were affected to different degrees by these problems. More affected banks reduced credit by more than the rest of the banking sector. At the same time, given the overall tightening in credit standards, borrowers could not compensate for this reduction by obtaining credit from less affected banks or other alternative sources of external finance. These mechanisms contribute to amplify the reduction in investment and employment.

The impact was also asymmetric across the size distribution of non-financial firms. Consistent with earlier empirical findings of Gertler & Gilchrist (1994) and theoretical arguments that financial constraints deriving from asymmetric information are more relevant for smaller and less transparent firms, Bottero et al. (2015) find that credit for smaller and riskier firms with high exposure to affected banks was reduced more than for those with low exposure. Moreover, the authors find that this had a significant negative effect on their investment and employment decisions. At the same time, investment and employment of large firms were not significantly affected. This asymmetry is also related to the fact that smaller firms are more dependent on their main partner bank. Many studies find that firms whose initial loan application was rejected could not compensate for the decline in external fi...

Table of contents

• Cover
• About the EIB
• Title page
• 1. Introduction
• 2. Related Literature
• 3. Data and estimated relation
• 4. Main results
• 5. Robustness Checks
• 6. Concluding remarks
• References
• Annexes
• Notes
• Copyright page
• Newsletter page