Bank Funding Risk, Reference Rates, and Credit Supply

Pre-committed revolving credit lines tend to be drawn heavily when bank funding markets are stressed, presenting an important funding risk to banks. Until recently, banks have mitigated this funding risk by linking the interest paid on lines to risksensitive reference rates such as the London Interbank Offered Rate (LIBOR). We show that incentives to provide credit lines are dampened by the debt-overhang cost to bank shareholders associated with funding stressed-market drawdowns. However, the associated adverse effect on credit supply is attenuated if: (1) drawdowns are expected be left on deposit at the same bank, which occurred at the largest banks during the COVID shock of March 2020, and (2) revolvers are linked to creditsensitive reference rates that reduce borrower incentives to draw more heavily on their lines during stressed markets. We estimate how the replacement of LIBOR with risk-free alternative reference rates will affect the supply of revolving credit. JEL: G00, G01, G02, G20, G21, E4, E43