NEW YORK – COVID-19 has sent U.S. businesses both big and small to seek relief from the financial distress of the current recession, but smaller companies are not receiving the same loan support from U.S. banks as their larger counterparts. A new study by Columbia Business School Associate Professor of Business Olivier Darmouni finds that smaller businesses are subjected to stricter loan terms, preventing them access to liquidity during bad times like the current pandemic.
In the first half of 2020, bank credit increased almost entirely because of drawdowns by large companies, a privilege that smaller businesses did not have. The difference? Large companies were able to pull from pre-committed credit lines often out of reach for smaller businesses. The study, co-authored by Harvard University Associate Professor of Economics Gabriel Chodorow-Reich and the Federal Reserve Bank of New York’s Stephan Luck and Matthew Plosser, draws on loan-level data that covers two-thirds of all corporate loans from U.S. banks to build a framework that looks at the differences in loan terms based on the size of the companies receiving the loans. The framework uses five qualities of loan agreements to reflect either lender commitment or lender discretion. The researchers find that smaller businesses tend to receive unmanaged, short-term credit lines that often result in rollovers. These loans come with higher collateral requirements, utilization rates, and pricing spreads than those granted to larger companies. These loan terms combine to provide lender discretion, or the ability to deny requests for funds in real-time. By contrast, larger companies’ loan terms reflect lender commitment and are more flexible as the borrower can draw on pre-established credit limits at-will.
But there’s still hope for smaller businesses in need of relief: government-sponsored liquidity. The researchers add that smaller companies who received Paycheck Protection Program (PPP) loans reduced their bank borrowing in 2020Q2 by between 53% and 125% of their PPP loan’s amount. With the revival of the PPP also comes a chance to level the lending playing field for small businesses.
The study, Bank Liquidity Provision Across the Firm Size Distribution, is available online here.
To learn more about the cutting-edge research being conducted at Columbia Business School, please visit www.gsb.columbia.edu.
About the researcher
Professor Olivier Darmouni is a financial economist whose research interests span corporate finance, banking and industrial organization. He applies a variety of empirical methods...Read more.