Export shocks and banks’ domestic credit: Balancing liquidity provision and risk mitigation

This paper explores how a demand shock in an export market propagates through the domestic banking system. The 2014 dual shocks of sanctions and falling oil prices significantly reduced sales for Italian exporters to Russia, leading to increased liquidity needs. Banks more exposed to these exporters accommodated their credit demand to address liquidity shortfalls but simultaneously reduced credit supply, especially to ex ante risky borrowers not directly affected by the shock. Our findings suggest a bank capital channel at play, mitigating trade shocks for some firms while transmitting them to the broader economy.