Banks’ Equity Stakes in Firms: A Blessing or Curse in Credit Markets?

Abstract

We analyze how banks’ equity stakes in firms influence their credit supply in crisis times. For identification, we exploit the 2008 Global Financial Crisis and merge unique supervisory data from the German credit register on individual bank-firm credit exposures with the security register data that include banks’ equity holdings. We find that a large and ex-ante persistent equity position held by a bank in a firm is associated with a larger credit provision from the respective bank to that firm. In crisis times, however, equity stakes only foster credit supply to ex-ante riskier firms especially from relatively weak banks. This ex-ante risk-taking may be due to better (insider) information by the bank, including a traditional lending relationship over the crisis. However, this ex-ante riskier lending translates also into higher ex-post loan defaults, worse firm-level stock market returns and even more firm bankruptcy or restructuring cases. Our results therefore suggest that banks’ equity stakes in their borrowers do not mitigate debt overhang problems of distressed firms in crisis times, but rather foster evergreening of banks’ outstanding credit to those (zombie) firms.