Lender Concentration of External Debts and Sudden Stops

Abstract

This paper studies how the lender structure of external debts affects open economies' credit conditions via a model with heterogeneous lenders of different sizes. While atomic lenders take the collateral price as given, large lenders internalize the pecuniary externality whereby selling foreclosed collateral injects supply and reduces its price. Thus, concentrating external debt in a few large lenders alleviates sudden stops and supports a high collateral price, making borrowers demand less precautionary saving and overborrow more. I document that emerging countries borrow from significantly fewer US banks than advanced countries, implying that emerging countries tend to overborrow. This new mechanism complements the existing view that overborrowing results from the pecuniary externality of borrowers. Under plausible parameterization, the size of the pecuniary externality internalized by lenders is one-third of that internalized by borrowers. Finally, allowing lender countries to optimally choose lender structure increases lender concentration, raises debt, and lowers borrowers' consumption.

Keywords: Sudden stops, Pecuniary externality, Overborrowing, Lender structure