Sovereign-Bank Diabolic Loop: The Government Procurement Channel

Diana Bonfim, Sujiao Zhao and Miguel A. Ferreira
Authors registered in the RePEc Author Service: Francisco Queiró

Working Papers from Banco de Portugal, Economics and Research Department

Abstract: We show that banks’ lending exposure to firms with government procurement contracts can amplify the diabolic loop between sovereigns and banks. Using the fiscal austerity measures implemented during the 2010-2011 European sovereign debt crisis as a shock to government procurement, we find that banks with higher exposure to these firms reduced lending significantly more than banks with lower exposure, controlling for firm-specific credit demand. The reduction in credit supply is economically as important as the effect of banks’ sovereign debt holdings, and affected both firms with and without government contracts. Firms with lending relationships with affected banks experienced lower sales growth, assets growth, employment growth, and investment. This decrease in real economic activity is likely to reduce tax revenue, further amplifying the diabolic loop.

JEL-codes: G01 G20 G31 H57 (search for similar items in EconPapers)
Date: 2021
New Economics Papers: this item is included in nep-ban, nep-eec and nep-fdg
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Persistent link: https://EconPapers.repec.org/RePEc:ptu:wpaper:w202109

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