Loan supply, credit markets and the euro area financial crisis

We derive a measure of loan supply shocks from proprietary bank-level information on credit standards from the euro area Bank Lending Survey (BLS) controlling for both macroeconomic and bank-specific demand factors. Using this indicator as an external instrument in a Bayesian vector autoregressive (BVAR) model, we find that a tightening of credit standards – i.e. banks’ internal guidelines or loan approval criteria – leads to a protracted contraction in credit volumes intermediated by banks and higher lending margins. This fosters firms’ incentives to substitute bank loans with market finance, ultimately producing a significant increase in debt securities issuance and higher corporate bond spreads. We also show that widely-used measures of financial uncertainty do not influence or drive our results.