When Losses Turn into Loans: The Cost of Undercapitalized Banks

73 Pages Posted: 10 Apr 2019

See all articles by Laura Blattner

Laura Blattner

Stanford Graduate School of Business

Luísa Farinha

Bank of Portugal

Francisca Rebelo

Boston College, Department of Finance

Date Written: January 28, 2019

Abstract

We provide evidence that a weak banking sector has contributed to low productivity growth following the European sovereign debt crisis. An unexpected increase in capital requirements for a subset of Portuguese banks in 2011 provides a natural experiment to study the effects of reduced bank capital adequacy on productivity. Affected banks respond not only by cutting back on lending but also by reallocating credit to firms in financial distress with prior underreported loan loss provisioning. We develop a method to detect when banks delay loss reporting using detailed loan-level data. We then show that the credit reallocation leads to a reallocation of production factors across firms. A partial equilibrium exercise suggests that the resulting increase in factor misallocation accounts for 20% of the decline in productivity in Portugal in 2012.

Keywords: bank capital, productivity, misallocation, banking regulation, non-performing loans

JEL Classification: G21, G38, E51, D24, O47

Suggested Citation

Blattner, Laura and Farinha, Luísa and Rebelo, Francisca, When Losses Turn into Loans: The Cost of Undercapitalized Banks (January 28, 2019). ECB Working Paper No. 2228. Available at SSRN: https://ssrn.com/abstract=3366998

Laura Blattner (Contact Author)

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

Luísa Farinha

Bank of Portugal ( email )

Rua Francisco Ribeiro, 2
Lisbon, 1150-165
Portugal

Francisca Rebelo

Boston College, Department of Finance ( email )

Chestnut Hill, MA
United States

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