Countries where businesses can easily raise finance in the bond market typically experience faster and stronger recoveries from a recession, according to research by Fabien Tripier and colleagues to be presented at the Royal Economic Society''s 2015 annual conference. These findings are important for the many European countries in which corporate bond markets are relatively poorly developed.
Analysing data on 93 recessions in 25 countries over the past quarter century, the study finds that:
• Countries with a higher share of bonds in business debt started recovering, on average, three quarters after the start of the recession compared with six quarters in countries with a lower share of bonds.
• Countries with a higher share of bonds in business debt recovered their pre-crisis level of GDP five quarters after the start of recession compared with 11 quarters in countries with a low share of bonds.
• During the US recession of 2008/09, since banks reduced their lending, businesses sought more funds from the public through the bond market. This was a common occurrence across countries recovering from a recession.
• Past recessions showed that when banks cut loans, the share of bonds in business debt internationally increased by 15% on average and 20% for the United States in 2008/09.
Following the global financial crisis, banks drastically reduced their lending, which affected the functioning of businesses. Failure of businesses affects the rest of the economy and prolongs the recession. Corporate bond markets offer a crucial alternative to firms seeking funds when banks can''t meet their credit needs and lead to quicker economic recoveries.
Fabien Tripier comments:
''Our findings are relevant for economic policy design, especially in the euro area where corporate debt markets are less developed.
''Diversification of firms'' external finance diminishes the risk of a credit crunch when there are banking sector disturbances.''
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The total credit to the US nonfinancial corporations declined during the Great Recession of 2008-09 and the structure of corporate debt shifted from bank debt to market debt.
This time-varying composition of corporate debt has been stressed as essential to understanding the transmission of the financial crisis to the non-financial sector. Indeed, the issuance of market debt helped firms to mitigate the contraction in the supply of bank debt by troubled banks. In line with these findings, the European Commission (2014) advocates developing markets for corporate debt securities to replace impaired bank lending during recessions. But besides the recent US experience, the macroeconomic evidence of the cyclical behaviour of the corporate debt structure is relatively scarce.
This study fills the gap by providing a cross-country study of the business cycle behaviour of corporate debt structure from 93 recessions in 25 countries since 1989.
The researchers show that even if the 2008/09 US recession has been exceptional, it is not the case for the behaviour of the corporate debt structure. The bond-loan substitution during this recession led to 20% increase in the bond share, close to the 15% increase observed on average in the study''s panel of recessions.
The research then assesses whether high access to bond finance is associated with milder recessions and stronger recoveries.
The study shows that the expansion starts earlier in economies with high bond share (on average three quarters after the start of the recession against six quarters in the economies with low bond share).
The gap is even stronger in the following periods. The economies with high bond share recover the pre-crisis level of real GDP five quarters after the start of the recession against 11 quarters in economies with low bond share. At this date, the real GDP of economies with high bond share is 5% above its peak value.
The economies with higher share of bonds in corporate debt and higher bond-loan substitution experience stronger recoveries.
These findings are relevant for economic policy design, especially in the euro area where corporate debt markets are less developed. Diversification of firms'' external finance diminishes the risk of credit crunch in the case of bank sector disturbances.
