Macroeconomic Instability and the Strategic Use of Credit Lines: Firm-Level Evidence and Policy Implications for Canada

Abstract

This study investigates the impact of macroeconomic instability on the use of credit lines as contingent liquidity alternatives in Canada, with a focus on firm-level heterogeneity and regulatory buffers. Using simulated firm-level data and empirical models grounded in recent macro-finance literature, the findings reveal that heightened volatility significantly increases reliance on credit lines, highlighting their role as precautionary instruments. However, this reliance may exacerbate systemic liquidity risks during common shocks, particularly when firms simultaneously draw down commitments. The analysis further demonstrates that regulatory buffers, such as capital and liquidity requirements, mitigate excessive credit line utilization, reinforcing the stabilizing role of macroprudential frameworks. Firm-specific characteristics, including leverage, profitability, and internal liquidity, also shape credit line strategies, underscoring the importance of micro-level resilience in safeguarding macro-level stability. The study concludes with policy recommendations emphasizing enhanced disclosure, differentiated regulatory approaches for small and large firms, stronger internal liquidity buffers, and international coordination of contingent liquidity oversight. These insights contribute to the literature on financial stability by integrating firm heterogeneity, regulatory design, and systemic liquidity risks in the context of Canadian financial markets.