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The effect of a banking crisis on bank-dependent borrowers

  • Sudheer Chava
  • Amiyatosh Purnanandam

How does the banking sector’s financial health affect bank-dependent borrowers’ performance? We use the exogenous shock to U.S. banking system during the Russian crisis of Fall 1998 as a natural experiment to separate the effect of borrower’s demand of credit from the bank’s ability to supply credit and estimate the effect of U.S. bank’s financial health on the U.S. borrower’s stock-market performance. In an event window of 16 days starting with the Russian sovereign-debt default and ending with the flight of capital from Brazil, a period characterized with significant adverse shocks to the U.S. banking sector and without any perceptible effect on the public-debt market, bank-dependent firms earned significantly lower returns than firms with access to public-debt market. These losses were more pronounced in bank-dependent firms with higher growth opportunities and lower financial flexibility. About a month later when liquidity conditions deteriorated in the public-debt market as well, return differential between the bank-dependent and other firms became insignificant. Finally, we show that the bank-dependent firms earned significantly higher returns around the FOMC meetings in which Fed provided additional liquidity to the banking-system. Overall, we provide strong causal evidence that negative shocks to banking sector adversely affect the bank-dependent borrowers.

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Paper provided by Federal Reserve Bank of Chicago in its series Proceedings with number 1030.

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Length: 367-385
Date of creation: 2006
Date of revision:
Publication status: Published in Conference on Bank Structure and Competition (2006: 42nd) ; Innovations in real estate markets : risk, rewards, and the role of regulation
Handle: RePEc:fip:fedhpr:1030
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