The Real Effects of Credit Contractions: A Firm-Level Analysis

Abstract:     
How costly are systemic credit contractions? We examine this question using episodes of systemic banking crises across many countries and compare firm sales, profitability and investment during crisis, post-crisis, and pre-crisis periods. We find that credit contractions are costly for firms and are of similar or higher magnitudes compared to costs of financial distress. The costs are higher for firms normally more reliant on the external capital market for their financing needs. Our results also show that externally dependent firms recover more quickly towards their pre-crisis levels of investment, and that the recovery is facilitated when the external capital market is "deep" or well developed. We find that the bank-lending channel mechanism is a more plausible explanation for the empirical effects of credit contractions than the borrowers' balance sheet channel.

Number of Pages in PDF File: 47

Keywords: External Financial Dependence, Systemic Liquidity Shock, Credit Contraction, Banking Crisis, Bank Lending Channel, Balance Sheet Effect

JEL Classification: E50, G01, G21, G30

working papers series