Working Paper: NBER ID: w12612
Authors: Atif Mian; Asim Ijaz Khwaja
Abstract: Do liquidity shocks matter? While even a simple `yes' or `no' presents identification challenges, going beyond this entails tracing how such shocks to lenders are passed on to borrowers, and whether borrowers can in turn cushion these shocks through the credit market. This paper does so by using data that follows all loans made by lenders to borrowing firms in Pakistan, and exploiting cross-bank variation in liquidity shocks induced by the unanticipated nuclear tests in 1998. We isolate the causal impact of the bank lending channel by showing that for the same firm borrowing from two different banks, its loan from the bank experiencing a 1% larger decline in liquidity drops by an additional 0.6%. The liquidity shock also lowers the probability of continued lending to old clients and extending credit to new ones. Although this lending channel affects all firms significantly, large firms and those with strong business and political ties completely compensate the effect by borrowing more from more liquid banks - both through existing and new banking relationships. In contrast, small unconnected firms are entirely unable to hedge and face large drops in overall borrowing and increased financial distress. The liquidity shocks thus have large distributional consequences.
Keywords: bank liquidity; liquidity shocks; emerging markets; lending behavior; financial distress
JEL Codes: E44; E51; G21; G3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| 1% decline in bank liquidity (F65) | 0.6% reduction in loan amount provided (G51) |
| 1% decrease in bank liquidity (G21) | decrease in probability of lending to new clients by 12 basis points (G21) |
| 1% decrease in bank liquidity (G21) | decrease in probability of continuing lending to existing clients by 21 basis points (G21) |
| smaller, unconnected firms (L25) | significant drops in borrowing (H74) |
| inability of smaller firms to hedge against liquidity shocks (G33) | substantial distributional consequences (D39) |