Credit misallocation during the European financial crisis
BIS Working Papers No 669
This paper explores the extent and consequences of credit misallocation in Italy during and after the euro zone crisis, addressing two main questions: (i) What bank characteristics are more conducive to zombie lending? (ii) What is the cost of zombie lending in terms of lost economic activity and misallocation of real resources?
An important dimension of financial crises is a weakened banking sector. There is a widespread perception in the policy debate that undercapitalised banks can prolong crises by misallocating credit to weaker firms on the verge of bankruptcy and by restraining credit to healthy borrowers ("zombie lending").
The paper investigates the presence of zombie lending and its consequences using detailed micro data at the bank and firm level to control for demand effects, isolating a credit supply channel. Next, it tests whether a high share of credit from low-capital banks - those that distort credit towards zombie firms - in the local market harms the performance of healthy firms.
Undercapitalised banks were less likely to cut credit to zombie firms.
Credit misallocation increased the failure rate of healthy firms and lowered the failure rate of zombie firms.
However, the adverse effects of credit misallocation on the growth rate of healthy firms were modest, as were the effects on total factor productivity (TFP) dispersion.
Do banks with low capital extend excessive credit to weak firms, and does this matter for aggregate efficiency? Using a unique dataset that covers almost all bank-firm relationships in Italy in the period 2004-2013, we find that during the Eurozone financial crisis (i) undercapitalized banks were less likely to cut credit to non-viable firms; (ii) credit misallocation increased the failure rate of healthy firms and reduced the failure rate of non-viable firms and (iii) nevertheless, the adverse effects of credit misallocation on the growth rate of healthier firms were negligible, as were the effects on TFP dispersion. This goes against previous influential findings, which, we argue, face serious identification problems. Thus, while banks with low capital can be an important source of aggregate inefficiency in the long run, their contribution to the severity of the great recession via capital misallocation was modest.
JEL classification: D23, E24, G21
Keywords: bank capitalization, zombie lending, capital misallocation