Lender concentration of external debts and sudden stops

This paper studies how the lender structure of external debt affects open economies’ credit conditions via a model with lenders of varying sizes. While atomistic 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 supports a high collateral price during financial downturns, leading borrowers to demand less precautionary savings and overborrow. I document that emerging countries borrow from significantly fewer banks than advanced countries, implying that emerging countries tend to overborrow. This new mechanism complements the existing view of overborrowing due to the pecuniary externality of the borrowers. Under plausible parameterization, the size of the pecuniary externality internalized by lenders is two-thirds of that internalized by borrowers. Finally, allowing lender countries to optimally choose lender structure increases lender concentration, raises debt, and improves borrowers’ welfare.