Quo Vadis? Bank Closures, Firm Performance, and New Bank-Firm Relationships

How do firms respond to sudden and forcible closures of their lenders? Using unique credit register data from a setting where two-thirds of banks were closed within a decade, we find that neither bad nor good firms delay repayments or switch lenders before closures. Afterward, bad firms lose subsidized credit and experience sharp declines in employment, borrowing, and sales, while good firms improve performance. This divergence stems from banks’ prior underpricing of bad firms’ credit risk. Ultimately, good firms match with new solid banks, while bad firms gravitate toward not-yet-detected weak banks---especially where boards overlap or markets are unconcentrated.