Academic

One possibility is that they worry about borrower credit risk, though worries need to be extreme to justify the substantial drop in term lending. A second is that they may worry about having enough liquidity of their own, if their creditors demand funds. Yet, the many Federal Reserve facilities that have been opened should assuage these concerns.

Perhaps, however, it is not just the fear of being short of funds to meet creditor demands that drives the reluctance of even healthy banks to lend, but the fear of being short of funds if investment opportunities get even better. Take, for example, the possibility that a large indebted financial institution becomes distressed in the future and starts dumping assets in the market.

Not only will the price of those assets fall if there are only a few entities with the liquid funds to buy them, the absorption of market liquidity by the distressed institution will ensure that it will be very hard for any institution that does not already have liquid funds to borrow at that time. If financial institutions expect that those with liquidity could make a killing in the future (by buying financial assets or banks at fire sale prices), they will restrict their lending or investment today to very short maturities or liquid securities and not lock up liquidity in term loans. The point is that it need not be ?own? distress that prevents a bank from lending, expectations of liquidity shortages that may cause other distressed entities to sell in a future fire sale can be enough.