We provide evidence that a weak banking sector has contributed to low productivity growth in the aftermath of 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. Using detailed administrative data from the Bank of Portugal, we show that affected banks respond not only by cutting back on lending but also by increasing their underreporting of loan losses, which inflates reported capital, and by reallocating credit to firms in financial distress with prior underreported losses. To establish these results, we develop a method to detect the underreporting of losses using detailed loan-level data. We argue that this credit reallocation is consistent with distorted lending incentives arising either from the attempt to avoid the recognition of underreported losses, or from gambling on risky firms in response to an expected government bailout. We then show that the credit reallocation affects firm-level investment and employment. Finally, we translate the firm-level changes into aggregate productivity. This partial equilibrium exercise suggests that the credit reallocation driven by the regulatory intervention accounts for 20% of the decline in productivity in Portugal in 2012.
We study how debt frictions and demand affect corporate investment using administrative data from a large temporary investment tax credit in Portugal. We obtain exogenous variation in demand for exporting firms from product-destination-level changes in foreign demand. We proxy debt frictions by an index of different debt-earnings ratios. We find that debt has a strong, non-linear effect on the likelihood that a firm invests in response to the tax credit. Firms in the lower two quartiles of our debt-earnings index have roughly equal predicted take-up probabilities. For firms in the third quartile predicted take-up drops by 50% while firms in the worst debt-earnings quartile have a predicted take-up rate close to zero. We show that the effect of demand is mediated by the size of a firm's debt burden. While demand has a strong positive effect for the bottom debt quartiles, demand ceases to affect take-up in the highest debt quartile. These results highlight that the distribution of debt, rather than the absolute stock of debt, matters for understanding post-crisis investment dynamics.
This paper studies the transmission channels of the European Central Bank's (ECB) asset purchase programs via the banking sector using proprietary data from the Bank of Portugal. Banks that hold larger amounts of assets eligible for ECB purchase prior to announcement of the programs realize trading profits from selling these assets following the announcement. Banks use most of these gains to increase their cash holdings. We find a moderate positive effect on loan approval rates for new corporate borrowers, which is stronger for riskier borrowers. However, banks do not offer significantly lower interest rates or provide additional loans to existing customers. We investigate an additional origination channel. The ECB's purchase of asset-backed securities (ABS) and covered bonds does not lead banks with pre-existing issuance technology to originate more loans. Our results suggest that the pass-through of asset purchase programs to lending conditions may occur through channels other than bank balance sheets.
We examine how the composition of public debt, broken down by currency, maturity, holder profile and marketability, has responded to major debt accumulation and consolidation episodes during 1900-2011. Covering thirteen advanced economies, we focus on debt structure shifts that occurred around the two World Wars and global economic downturns, and the subsequent debt consolidations. Notwithstanding data gaps, we are able to recover some broad common patterns. Episodes of large debt accumulation—essentially, large increases in debt supply— were typically absorbed by increases in short-term, foreign currency-denominated, and banking-system-held debt. However, this pattern did not hold during the debt build-ups starting in the 1980s and 1990s, which were compositionally skewed toward long-term local-currency debt. We attribute this change to higher structural demand for sovereign paper, linked to capital account liberalization in advanced economies, the emergence of a large contractual saving sector, and innovative sovereign debt products. With regard to debt consolidations, we find support for the financial repression-cum-inflation channel for post World War II debt reductions. However, the scope for a repeat of this strategy appears limited unless financial liberalization and globalization were materially rolled back or the current globally agreed monetary policy regime built around price stability abandoned. Neither are significant favorable structural demand shifts, as witnessed in the 1980s and 1990s, likely.