Sorting Out the Real Effects of Credit Supply
48 Pages Posted: 9 Apr 2020 Last revised: 17 May 2021
Date Written: May 17, 2021
We document that banks which cut lending more during the Great Recession were lending to riskier firms. To explain this evidence, we build a competitive matching model of bank-firm relationships in which risky firms borrow from banks with low holding costs. Based on default probabilities and equilibrium loan rates, we use our sorting model to recover the latent bank holding cost distribution. The measure of banks with low holding costs dropped during the Great Recession. This credit supply shift conservatively accounted for around 50% of the decline in corporate loans over this period. Our attribution cannot be captured by panel regression estimates from the bank lending channel literature.
Keywords: Credit supply, Financial Crises, Matching Model, Credit Risk
JEL Classification: G01, G21, G2, G23
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