Sovereign Debt Exposure and the Bank Lending Channel: Impact on Credit Supply and the Real Economy

We study the impact of sovereign market tensions on the real economy through the bank lending channel. Using a large matched bank-firm panel data set that tracks credit relations in Italy over the period 2009-2011, we show that the Greek bailout in the spring of 2010 had a negative impact on the riskiness of government securities held in the portfolio of financial intermediaries, which in turn led to a tightening in credit supply to firms. Firms, especially riskier ones, were unable to smooth out the credit shortage. We estimate that the shock to sovereign bonds led, via the lending channel, to a drop in aggregate bank lending to corporations of almost 2 percent over the subsequent year which translated in a reduction of investment by smaller firms.