Stimulating credit through banks’ unsecured debt purchases: Insights from a non-traditional measure

This paper examines the effectiveness of a novel monetary policy instrument—central bank purchases of commercial banks’ unsecured bonds—on bank credit supply. As part of its COVID-19 response in July 2020, the Bank of Israel uniquely included purchases of banks’ unsecured debt issued through publicly tradable bonds in its corporate bond purchase program. This differed from most similar programs globally that focused solely on corporate securities. Using confidential datasets of individual central bank purchases and bank-level borrower credit, I employ Khwaja and Mian’s (2008) analytical framework with borrower fixed effects to isolate supply effects from demand factors. The results demonstrate that the share of bank bonds purchased by the Bank of Israel led to a significant increase in credit supply. An analysis of the transmission channels reveals that changes in bondholder composition—specifically the shift from “unstable hands” investors to the stable, buy-and-hold, Bank of Israel— drove these effects by restoring market confidence and inducing deposit inflows. Consequently, banks with higher pre-program shares of price-sensitive bondholders experienced larger deposit inflows and exhibited substantially stronger credit responses. This study contributes to the literature by documenting a novel policy instrument for expanding the supply of bank credit and providing the first evidence that changes in banks’ debtholder composition affect their provision of credit.