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When losses turn into loans: the cost of undercapitalized banks

Laura Blattner, Luísa Farinha and Francisca Rebelo

No 2228, Working Paper Series from European Central Bank

Abstract: We provide evidence that a weak banking sector has contributed to low productivity growth following the European sovereign debt crisis. An unexpected increase in capital requirements for a subset of Portuguese banks in 2011 provides a natural experiment to study the effects of reduced bank capital adequacy on productivity. Affected banks respond not only by cutting back on lending but also by reallocating credit to firms in financial distress with prior underreported loan loss provisioning. We develop a method to detect when banks delay loss reporting using detailed loan-level data. We then show that the credit reallocation leads to a reallocation of production factors across rms. A partial equilibrium exercise suggests that the resulting increase in factor misallocation accounts for 20% of the decline in productivity in Portugal in 2012. JEL Classification: G21, G38, E51, D24, O47

Keywords: bank capital; banking regulation; misallocation; non-performing loans; productivity (search for similar items in EconPapers)
Date: 2019-01
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