Relationship Lending in Shadow Banking: Cross-Holding Relation through Money Market Funds

This paper explores the nature and impacts of shadow banks’ relationship lending by analyzing bilateral-connected financial firms who mutually hold each other’s debt through their own affiliated money market funds (MMFs). Using novel MMFs’ monthly holdings data, I show that, in the context of the 2011 Eurozone crisis, non-European financial firms surprisingly increased their MMFs’ stakes in bilateralconnected European financial firms, while MMFs generally reduced their exposure to European issuers. I provide evidence that this bias represents reciprocity between the bilateral-connected financial firms. In return, the European financial firms, through their affiliated MMFs, accepted more insecure than secure debt from their bilaterally-connected non-European partners during the same period. Issueror fundcharacteristics do not explain the results. Similar tests show that cross-holding relation (CHR) affects MMFs’ lending after the 2013 Dodd-Frank stress test in the same pattern. A further investigation shows that CHR also affects issuers unconnected with MMFs, because they are unable to raise money from new funds in a short time after their old lenders cut off the financing. JEL classifications: G21, G32, G10, G14