Below is a thread about something that became quite obvious during the last days - the importance of insurance in the global financial system. This thread is about *banks as liquidity insurers* and some implications for the #COVIDー19 crisis 1/n
The virus and the drastic ways governments took to contain its spreading, had an immediate impact on the real economy through the simultaneous occurrence of both demand and supply shocks. Liquidity quickly evaporates among small and large companies. 2/n
But also the banking sector was severely under pressure. An important reason is the role of banks as liquidity insurer for the real economy. While non-bank financial institutions took over a large share of corporate financing over the past years, ... 3/n
...particularly of highly leveraged firms, banks still are the main source of liquidity insurance for all firms, investment-grade, non-investment grade and also unrated firms. Firms with liquidity problems might use this insurance and start drawing down their credit lines. 4/n
Worse, liquidity needs potentially become highly correlated among firms and they all start running at their banks. Moreover, the draw-downs require a lot of bank capital as they manifest as loans on their balance sheet constraining significantly their lending ability. 5/n
A liquidity problem can thus quickly become a solvency problem for banks. It thus makes sense to quantify the insurance function of banks at the start of this crisis and investigate what past-experience can tell us about what might happen now. 6/n
This is about US firms (due to data availability) but the notion applies to European banks as well. I use evidence from about 2,300 US firms with information on outstanding credit lines. 7/n
The total amount of outstanding credit lines of US non-financial firms at the end of 2019 is USD 962 billion. The total debt that these companies carry is USD 5.2 trillion, i.e. banks provide, on average, 17.5% of company debt as liquidity insurance. 8/n
69% of these firms are unrated, 18% non-investment grade rated, 9% BBB rated and only 4% are AAA/AA or A-rated. This table shows undrawn credit lines per rating class. 
In earlier threads I have shown the current stress in loan markets suggesting a tightening of credit conditions particularly for leveraged firms. Tightened spot credit market conditions might encourage particularly these firms to draw from their credit lines. 10/n
I showed in an earlier tweet evidence from my 2016 JF paper on credit line drawdowns that suggest some I think reasonable and even conservative estimates as to what we could expect in terms of drawn downs during the crisis. We can apply this to the current situation 11/n
Table 3 shows the calculation of the expected draw-downs of US firms, which amounts to about USD 264 billion based on historical drawn-down rates. Assuming a 10% capital requirement suggests a capital need of about USD 26 billion for banks providing liquidity insurance. 12/n
There is a lot more work to do (who provides the insurance, how concentrated is this insurance function etc) but it gives us some actual data points how valuable the insurance function of banks in liquidity provision for firms is. n/n
I think this is an exercise would be very valuable also in the Eurozone, for regulators and politicians when deciding about their approach how to provide liquidity to firms. @Isabel_Schnabel @JanKrahnen @MarkusEconomist @VMRConstancio @FuestClemens @nicolas_veron @ErikFossing
