Tracing the Impact of Bank Liquidity Shocks: Evidence from an Emerging Market
Posted: 4 Nov 2008
Date Written: November 3, 2008
We examine the impact of liquidity shocks by exploiting cross-bank liquidity variation induced by unanticipated nuclear tests in Pakistan. We show that for the same firm borrowing from two different banks, its loan from the bank experiencing a 1% larger decline in liquidity drops by an additional 0.6%. While banks pass their liquidity shocks on to firms, large firms - particularly those with strong business or political ties - completely compensate this loss by additional borrowing through the credit market. Small firms are unable to do so and face large drops in overall borrowing and increased financial distress.
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