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The Real Side of the Financial Crisis: Banks' Exposure, Flight to Quality and Firms' Investment Rate

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Abstract

This paper takes advantage of the Italian experience during the Lehman crisis to test the effects of a banking shock on the real decisions of client firms. Italy is an ideal laboratory because of the structure of its industrial system, mainly composed by small firms, that make large use of (short-term) bank debt and have no access to alternative sources of finance. Moreover, the financial crisis represented an unexpected event that was largely exogenous to the financial position of both Italian banks and firms. This provides a quasi-natural experiment to study the effect of supply shocks on the real economy. The analysis is performed exploiting the information on the lender-borrower relationship from a newly available survey on a representative sample of small and medium enterprises. The magnitude of the shock is modeled with bank pre-crisis exposures to Dollar-denominated assets and liabilities, then interacted with time-varying market measures on the riskiness of the U.S. system (CDS spreads). After controlling for demand conditions I find robust evidence that banks' exposures to Dollar-denominated items affect the investment rate, the amount of borrowing, and the probability of financial constraints of their client firms. The mechanism of transmission is characterized by a flight to quality, with a redistribution of loans away from riskier borrowers. Furthermore, the effects are stronger for firms that borrow from undercapitalized and illiquid banks or financial institutions that depend more upon bank-based sources of finance.

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Bibliographic Info

Paper provided by Tor Vergata University, CEIS in its series CEIS Research Paper with number 302.

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Length: 63 pages
Date of creation: 18 Dec 2013
Date of revision: 18 Dec 2013
Handle: RePEc:rtv:ceisrp:302

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Postal: CEIS - Centre for Economic and International Studies - Faculty of Economics - University of Rome "Tor Vergata" - Via Columbia, 2 00133 Roma
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Postal: CEIS - Centre for Economic and International Studies - Faculty of Economics - University of Rome "Tor Vergata" - Via Columbia, 2 00133 Roma
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Web: http://www.ceistorvergata.it

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Keywords: Financial crises; banks; lending; investment; flight to quality; financial constraints;

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References

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