Victoria Ivashina on Bank Lending in the 2008 Financial Crisis

New Hot Paper Commentary, September 2011

Victoria Ivashina

Article: Bank lending during the financial crisis of 2008

Authors: Ivashina, V;Scharfstein, D
Volume: 97, Issue: 3, Page: 319-338, Year: Sp. Iss. SI SEP 2010
* Harvard Univ, Sch Business, Cambridge, MA 02138 USA.
* Harvard Univ, Sch Business, Cambridge, MA 02138 USA.
* NBER, Cambridge, MA 02138 USA.

Victoria Ivashina talks with and answers a few questions about this month's New Hot Paper in the field of Economics & Business.

SW: Why do you think your paper is highly cited?

Our paper answers several questions fundamental to understanding the propagation of the most recent economic crisis. Specifically we show that corporate lending started to fall in mid-2007, with the fall accelerating during the banking panic that began in September 2008.

We also show strong evidence that credit supply contraction was the driving force behind the observed fall (vs. lack of demand for credit). Shifts in credit supply and demand differ in terms of welfare costs and the channel through which monetary policy operates. Also, TARP and other policies that aim to stimulate lending by directly providing financial support to the banks are indirectly based on the premise that bank-loan supply is low. So it is important to tell the supply and demand effects apart.

Victoria Ivashina
Coauthor David Scharfstein.

SW: Does it describe a new discovery, methodology, or synthesis of knowledge?

One important aspect of our study was that we were the first to point out and document that after the failure of Lehman Brothers in September 2008 there was a run by borrowers who drew down their credit lines. It changed fundamentally the way we think about a run on a bank. In a traditional bank run (think It's a Wonderful Life), the depositors rush to the bank to withdraw their savings, suddenly shrinking the bank's funding. The deposits insurance instituted in the US after the Great Depression prevents that from happening in the modern financial system. (Banks that fund themselves through short-term non-insured funding would still find themselves under a severe constraint and contract credit, and we show that in our paper.)

However, a novel point that emerged from our study, is that a run on revolving credit lines—a flexible type of credit similar to a credit card held by consumers—is also an important force and it is very similar in nature to the run on deposits (although it is a run on credit). Ironically, when a run takes place, the amount of new loans that appear on the banks' balance sheets rises very quickly. So if one would be asking whether the banks are lending based on the information collected by the Fed (balance sheet information), it would appear that it is the case.

In fact, when our study came out, several prominent economists took a position that the credit supply was indeed expanding—exactly the opposite of our finding. This measurement mistake was rooted in a misunderstanding of the nature of the revolving credit.

SW: Would you summarize the significance of your paper in layman's terms?

A large fraction of firms, in particular small and medium firms, are dependent on the availability of bank credit. If a firm cannot renew its loan, or it cannot do it at an affordable cost, it will likely have to curtail its spending by contracting the scale of its operations and laying off its employees. If many firms in the economy are affected, one can see how this becomes a macroeconomic problem. So, understanding whether the banks are lending and, if not, why, is central to understanding prospects of the economy. This is particularly important in moments of stress like the Fall of 2008.

SW: How did you become involved in this research, and how would you describe the particular challenges, setbacks, and successes that you've encountered along the way?

"Our study has been widely cited by policymakers and practitioners and it has been quite influential in understanding the role of government programs."

Since well before the crisis, my research has focused on banks and the corporate credit market. Most of my research aims to expand our understanding of the modern banking system and its effect on the real economy. The recent crisis left us with many urgent questions, and it has been fun engaging in this debate by writing this paper.

SW: Where do you see your research leading in the future?

I am broadly interested in understanding the role of financial intermediaries on economic activity. Some of my recent work looks to operationalize the measurement of bank credit supply to firms in a time-series context. Understanding the propagation of the most recent crisis will help us to extract the right lessons going forward, yet it does not fully prepare us for the next crisis. The question, "Are banks lending?" will emerge again, and we are not well positioned to answer this question quickly on an ongoing basis with the current tools and data.

However, in a recent study together with Bo Becker, we propose a variable that represents a significant improvement on the measurement of shifts in bank credit supply in a time series. This is something that can be easily tracked on a quarterly basis. This recent study confirms our findings with David Scharfstein, but it also indicates that despite a modest recovery, bank credit supply had remained depressed throughout 2010.

SW: Do you foresee any social or political implications for your research?

Our study has been widely cited by policymakers and practitioners and it has been quite influential in understanding the role of government programs. Myself and many other people have been working on expanding our understanding of the modern financial intermediaries as well as its interconnection with the production ("real") sector.End

Victoria Ivashina
Harvard Business School
Harvard University
Cambridge, MA, USA



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