Bank loan caps, debt substitution, and synchronization risk in credit crises

Abstract

We build a model of credit crises in which lenders delay exit from speculative sectors due to synchronization risk—uncertainty about when other lenders withdraw. Compared with nonbanks, banks recognize credit risk more quickly, withdraw earlier, and thereby help mitigate crises. When bank lending is capped, firms substitute toward nonbank debt, generating two opposing forces: a quantity effect, which lowers total debt, eases fire-sale pressure, and mitigates losses, and a substitution effect, which raises synchronization risk and amplifies crises. These forces imply a threshold substitution rate: below it, bank-lending caps mitigate crises; above it, they exacerbate them.