Sovereign-Bank Diabolic Loop: The Government Procurement Channel

78 Pages Posted: 8 Jul 2021

See all articles by Diana Bonfim

Diana Bonfim

Banco de Portugal; Catholic University of Portugal (UCP) - Catolica Lisbon School of Business and Economics

Miguel A. Ferreira

Nova School of Business and Economics; European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)

Francisco Queiro

Nova School of Business and Economics

Sujiao Zhao

Bank of Portugal - Department of Economics; Universidade do Porto - Faculdade de Economia (FEP)

Date Written: June 24, 2021

Abstract

We show that banks' lending exposure to firms with government procurement contracts can amplify the diabolic loop between sovereigns and banks. Using the fiscal austerity measures implemented during the 2010-2011 European sovereign debt crisis as a shock to government procurement, we find that banks with higher exposure to these firms reduced lending significantly more than banks with lower exposure, controlling for firm-specific credit demand. The reduction in credit supply is economically as important as the effect of banks' sovereign debt holdings, and affected both firms with and without government contracts. Firms with lending relationships with affected banks experienced lower sales growth, assets growth, employment growth, and investment. This decrease in real economic activity is likely to reduce tax revenue, further amplifying the diabolic loop.

Keywords: Credit supply, Government procurement, Investment, Employment, Financial crises, Bank-sovereign loop, Fiscal policy

JEL Classification: G01, G20, G31, H57

Suggested Citation

Bonfim, Diana and Ferreira, Miguel Almeida and Queiro, Francisco and Zhao, Sujiao, Sovereign-Bank Diabolic Loop: The Government Procurement Channel (June 24, 2021). Available at SSRN: https://ssrn.com/abstract=3873264 or http://dx.doi.org/10.2139/ssrn.3873264

Diana Bonfim

Banco de Portugal ( email )

Av Almirante Reis, 71
P-1150-012 Lisboa
Portugal

Catholic University of Portugal (UCP) - Catolica Lisbon School of Business and Economics ( email )

Palma de Cima
Lisbon, 1649-023
Portugal

Miguel Almeida Ferreira (Contact Author)

Nova School of Business and Economics ( email )

Campus de Campolide
Lisbon, 1099-032
Portugal

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Francisco Queiro

Nova School of Business and Economics ( email )

Lisbon, 1099-085
Portugal

Sujiao Zhao

Bank of Portugal - Department of Economics ( email )

Rua do Almada, 71
Porto, 4050-036
Portugal

Universidade do Porto - Faculdade de Economia (FEP) ( email )

Rua Roberto Frias
s/n
Porto, 4200-464
Portugal

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