Managing the Largest Liquidity Shock Ever Observed: Large Bank Lending in the Pandemic

22 Jun 2020
Read Time 3 mins
Categories :
Small Business Lending
, Value of Large Financial Institutions

New research by economists at Boston College and the Federal Reserve Board documents that the months following the onset of the COVID-19 pandemic in the United States saw the largest liquidity shock ever observed since data first became available in 1973. More specifically, companies that were impacted by the pandemic demanded an unprecedented amount of credit and liquidity from banks to continue meeting payroll and other financial obligations while much of the economy went on pause in response to widespread social distancing.  In this post, we highlight two key findings from this research. First, most of the increased demand for liquidity was met by large banks. Second, this unprecedented increase in liquidity demands put significant pressure on the liquidity reserves of large banks. Even so, large banks met client demands and provided much needed liquidity to the corporate sector while still maintaining adequate amounts of liquidity. Taken together, these findings underscore the fact that large banks have taken unprecedented actions to extend credit and support the economy during the pandemic.

Large Bank Lending in Response to the Pandemic

We have previously commented on the fact that large banks have leaned into this period of economic turmoil by lending robustly throughout the economy.  In a previous post, we reported that Financial Services Forum members increased their business lending in the first quarter of 2020 by $272 billion.  In addition, we have also shown how Forum members have provided companies with access to private capital through public markets as another means of providing much needed liquidity during the pandemic.  What is new about the Boston College/Federal Reserve research is that the authors show the extent to which the increased lending to companies has been driven by large banks – banks with total assets over $50 billion.  As shown in Figure 1 below, reproduced directly from the paper, large banks grew their lending by more than 20 percent at the onset of the pandemic while mid-sized and smaller banks grew their lending more modestly by about 5 percent.  Accordingly, large banks have demonstrably and clearly led the effort to provide credit and liquidity to businesses during the pandemic.

Figure 1: Cumulative C&I Loan Growth by Bank Size

Source: Li et al. “Banks as Lenders of First Resort: Evidence from the COVID-19 Crisis”

Increased Lending and Liquidity: There are No Free Lunches

Figure 1 clearly demonstrates the leadership of large banks in corporate lending during the pandemic.  What may be less clear is the cost borne by large banks in providing such large amounts of credit and liquidity to their clients.  Put simply, there are no free lunches.  A dollar of liquidity provided by a large bank to a business client is a dollar less of liquidity that the bank can use to shore up its own balance sheet.  Moreover, the experience of the last decade’s economic turmoil demonstrated the overwhelming importance of liquidity in determining which banks would remain viable during a period of prolonged stress.  Accordingly, the willingness of large banks to provide liquidity during the pandemic says quite a lot about their collective willingness to support their clients and the economy.  As the authors note, “the massive increase in take-down demand from loan commitments potentially put the largest banks under liquidity strain because these funds were spent rather than hoarded.”  At a time when banks could have made the easy choice to hold back on lending to preserve bank liquidity, they leaned into the pandemic and made unprecedented amounts of credit and liquidity available to the economy. 

Finally, it should also be noted that large banks also continued to prudently manage their overall liquidity.  Importantly, as we noted in a recent post, Forum members continued to increase their holdings of liquid assets over the past year. 

Conclusion

New research sheds light on the important role played by large banks during the COVID-19 pandemic.  Overwhelmingly, liquidity and credit provided to the corporate sector has been provided by large banks.  The amount of liquidity provided has been massive and, according to the authors, is the largest injection of liquidity by banks into the economy since data became available in the 1970s.  This provision of liquidity has not been costless.  Banks that provide liquidity to their clients maintain less liquidity for themselves, which can itself be a crucial resource during a period of economic turmoil.  Large banks’ willingness to provide liquidity at a time when the value of liquidity was near an all-time high speaks clearly to large banks’ ability and willingness to support their clients and the U.S. economy during a difficult period.  Forum members, in particular, continue to support businesses of all sizes through this pandemic. 

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