Bank lending in the euro area contracted sharply following the Lehman shock and during the euro debt crisis. Sluggish loan origination is both a symptom and catalyst for economic weakness. Typically, a loan squeeze is a consequence, not cause, of a downturn. During the euro debt crisis, however, banks’ balance sheet constraints and rising funding costs featured more prominently. 

Boom in corporate bond issuance is driven by substitution and favourable market conditions. We investigate the substitution between weak lending and lush bond markets. Our empirical analysis of 66,000 individual deals shows that rising bank CDS spreads are consistently associated with positive growth in securities underwriting and negative growth in loan syndication. This suggests that banks and clients switch funding instruments in times of financial stress.  

The corporate bond market cushioned about a third of the impact from the credit squeeze – at first glance. A well-developed bond market is thus an important element to increase financial resilience as it offers an alternative source of funding for the real economy and an alternative source of revenue to banks. But there are limits. We also note a worrying trend towards financial fragmentation during times of stress – the impact from rising CDS spreads on underwriting volumes is twice as large when the issuer resides in the home market of the bank – which limits diversification potential.  

Firms which are being denied loans are not necessarily the same companies that tap the bond market successfully. In fact, we count less than one thousand non-financial corporations in our sample that have issued bonds. This is a fairly exclusive circle. Not every firm is fit for the capital market. 

Market environment is favourable for issuers. We expect rising corporate bond yields going forward as economic recovery gains traction. This means that current conditions are attractive for potential issuers.