Real Effects of Financial Distress: The Role of Heterogeneity

Abstract

How severe are the real consequences of financial distress caused by sovereign debt crisis? What are the channels through which sovereign debt crisis affect banks and firms, and vice versa? Does firm heterogeneity matter? If yes, what are the important dimensions of heterogeneity? Using micro data from Portugal during the sovereign crisis starting in 2010, we address these questions. We make use of the Bank of Portugal's detailed credit registry database together with bank and firm balance sheets and income statements to conduct this analysis. We first study the direct effect of the sovereign crisis on bank balance sheets by analyzing the differential impact on firms that had relations with banks who were more exposed to the sovereign (pre-crisis). We find that more fragile firms that had relations with more exposed banks contracted more than their counterparts. Specifically we find leverage and maturity structure of debt to be important dimensions of heterogeneity determining a firm's fragility. Highly leveraged firms and those that had a larger share of short term debt contracted more during the sovereign debt crisis. We analyze firm performance on the basis of growth rate of employment, assets, liabilities and usage of intermediate commodities. We show that our findings are consistent with a simple model of leverage and maturity choice. We then document the spillover effects across firms that are mediated through the banking sector. To do this, we focus on the set of firms that were current on all their loans through the crisis, i.e., the set of performing firms. We find that performing firms that had relations with banks whose corporate loan balance sheet deteriorate by more were more affected by the sovereign crisis. Again, highly leveraged firms and those that had a larger share of short term debt contracted more during the sovereign debt crisis.

The Real Effects of Relationship Lending

“…Finally, Bottero et al (2015) extend the results to consider the real effects, finding weaker investment and employment in firms operating with banks with greater exposure to Italian sovereign debt, in line with Acharya et al (2015). Similar results are also obtained by Buera and Karmakar (2017) for Portuguese firms and by Balduzzi et al (2017) who analyse the real effects of an increase in bank funding costs for Italian firms.…”

To ask or not to ask? Bank capital requirements and loan collateralization

“…For instance, in column 1 the total effect is 0.345 − 0.92 * 0.085 ≈ 0.26, and in column 5, it is 0.381 − 0.75 * 0.118 ≈ 0.29. This result supports H2 as the EBA Capital Exercise leads to a more intensive pledging of low risk weight collateral, but to a muted degree for relationship borrowers 16.…”

“…17 In terms of our analysis, the requirement to maintain implies that we should not observe further increases, or decreases in the rate of collateralization of loans issued by treated banks compared to their peers. In 16 Since low-risk collateral includes government guarantees, we recognize that it is possible that the government or other financial institutions might have issued guarantees to further support potential borrowers in obtaining low risk weight collateral. This type of collateral does not constitute a significant share, and in appendix F we add Table F1 where we have excluded loans backed by such collateral from the sample.…”

Scarring and Corporate Debt

“…Campello et al (2010) find that credit constrained firms in the US, Europe and Asia had to undertake deeper cuts in employment, and technological and capital spending in 2008. Buera and Karmakar (2019) find that highly leveraged firms in Portugal contracted more in the aftermath of financial shocks. Kalemli-Özcan et al (2019) use European firm-bank matched data and find that firms with higher debt levels pre-GFC reduced their investment more after the crisis, with the effect stronger for firms holding short-term debt in countries with sovereign stress.…”