Credit Lines and the Liquidity Insurance Channel

Abstract

We suggest a new mechanism–the liquidity insurance channel–based on the widespread reliance of high credit quality firms on bank credit lines for liquidity management. Our model matches the patterns of usage of loans and credit lines in the cross-section of firms, and defines the conditions under which shocks to bank health affect primarily low or high credit quality firms. Our framework can explain why credit line origination is more cyclical than loan origination. Overall, we uncover a novel interaction between bank health and economic activity through the provision of bank credit lines to high credit quality firms.

Keywords: liquidity management, cash holdings, liquidity risk, investment, lending channel, credit lines

JEL Classification: G21, G31, G32, E22, E5