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Tracing the Impact of Bank Liquidity Shocks: Evidence from an Emerging Market

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  • Atif Mian
  • Asim Ijaz Khwaja

Abstract

Do liquidity shocks matter? While even a simple `yes' or `no' presents identification challenges, going beyond this entails tracing how such shocks to lenders are passed on to borrowers, and whether borrowers can in turn cushion these shocks through the credit market. This paper does so by using data that follows all loans made by lenders to borrowing firms in Pakistan, and exploiting cross-bank variation in liquidity shocks induced by the unanticipated nuclear tests in 1998. We isolate the causal impact of the bank lending channel by showing that for the same firm borrowing from two different banks, its loan from the bank experiencing a 1% larger decline in liquidity drops by an additional 0.6%. The liquidity shock also lowers the probability of continued lending to old clients and extending credit to new ones. Although this lending channel affects all firms significantly, large firms and those with strong business and political ties completely compensate the effect by borrowing more from more liquid banks - both through existing and new banking relationships. In contrast, small unconnected firms are entirely unable to hedge and face large drops in overall borrowing and increased financial distress. The liquidity shocks thus have large distributional consequences.

Suggested Citation

  • Atif Mian & Asim Ijaz Khwaja, 2006. "Tracing the Impact of Bank Liquidity Shocks: Evidence from an Emerging Market," NBER Working Papers 12612, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:12612
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    More about this item

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G3 - Financial Economics - - Corporate Finance and Governance

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