The Transmission of Liquidity Shocks: The Role of Internal Capital Markets and Bank Funding Strategies

TLDR: In this paper, the authors analyzed the transmission of bank-specific liquidity shocks triggered by a credit rating downgrade through the lending channel, and they found that credit rating downgrades are associated with an immediate and persistent decline in access to noncore deposits and wholesale funding, especially during the global financial crisis.

Abstract: 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.