Recallable Bank Lines of Credit and Cash Substitution: Evidence from German SMEs

For this study, a unique sample provided by a German universal bank reveals whether small and medium-sized enterprises (SMEs) actually use bank lines of credit to substitute for cash holdings. The bank has the right to recall these lines and charges considerably higher rates for using them compared with regular loans. However, because the bank does not require any upfront commitment or usage fee, rational SMEs should demand a line, such that comparisons of the cash holdings of SMEs with and without lines as a means to detect cash substitution effects becomes inapplicable. Therefore, this study proposes an alternative test that reveals that the impact of the line rate and line limit on cash holdings and line use by SMEs is in line with the trade-off theory of cash. Moreover, SMEs' adverse behavior when using lines, their creditworthiness, and the duration of the bank-client relationship all influence the terms and conditions surrounding the lines.