Do banks propagate debt market shocks?

Key words: Bank subordinate debt, bond spreads, lending channel, loan spreads. ∗The authors thank Mark Flannery and seminar participants at Federal Reserve Bank of San Francisco, Gersenzee summer workshop, and Bank of Brazil for useful comments. The views stated herein are those of the authors and are not necessarily the views of the Federal Reserve Banks of San Francisco or New York, or the Federal Reserve System. Do banks propagate debt market shocks? Over the years, U.S. banks have increasingly relied on the bond market to finance their business. This created the potential for a link between the bond market and the corpo-rate sector whereby borrowers, including those that do not rely on bond funding, became exposed to the conditions in the bond market. We investigate the importance of this link. Our results show that when the cost to access the bond market goes up, banks that rely on bond financing charge higher interest rates on their loans. Banks that rely exclusively on deposit funding follow bond financing banks and increase the interest rates on their loans, though by smaller amounts. Further, banks pass the bond market shocks predominantly to their risky borrowers that have access to the bond market and to their borrowers that do not have access to the bond market. These results show that banks propagate shocks to the bond market by passing them through their loan policies to their borrowers, including those that do not use bond financing.