The Impact of Bank Health on the Investment of Its Corporate Borrowers

This paper investigates the impact of changes in a bank’s health on the investment behavior of its current borrowers for a panel of U.S. firms. I find that, after controlling for aggregate credit availability and the condition of outside banks, firms reduce their investment when the health of their primary bank deteriorates. Specifically, a 2% increase in the loan nonperformance of a commercial bank leads to an 8 to 10% decrease in average investment for firms which maintain a primary borrowing relationship with the bank. This effect is only present while the firm maintains a borrowing relationship with the bank and does not appear to be driven by changes in region or industry specific investment opportunities. The health of the existing lender is more important for younger, more opaque firms with greater reliance on their primary bank. I also find that this effect became less significant after the early 1990s, suggesting that bank dependence appears to diminish during long periods of stability. However, results from the recent financial crisis show that healthy banking relationships remain very important to U.S.