Small Firms and Domestic Bank Dependence in Europe’s Great Recession

The paper studies the role of small businesses (SME) in the transmission of the Eurozone crisis to member countries and whether regions or countries with many SMEs were less able to share risk. Our analysis draws attention to domestic bank dependence—defined as the share of domestic private credit originated by domestic banks—as a key variable modulated the impact of shocks on bankdependent SMEs and thus on the real economy. We argue that Eurozone banking integration in the years after the creation of the single currency was lopsided in the sense that, until 2008, cross-border lending between banks increased markedly while foreign banks’ lending to the real sector stayed relatively flat. Hence, SMEs remained very dependent on domestic banks for credit, in spite of high levels of banking sector integration between Eurozone countries. Our results suggest that domestic bank dependence made countries, regions, and sectors with many SMEs more vulnerable to global banking sector shocks and, at the same time, provided little risk sharing.