Cross-Border Banking And The International Transmission Of Financial Distress

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Executive Summary

The authors study the effect of financial distress in foreign parent banks on local SME financing in 14 European countries during the early stages of the 2007-2008 financial crisis. The available information on firms that select themselves out of the business loan application process enables one to identify a supply shock to local bank lending that is independent of the recession-driven shock on loan demand. They find strong evidence for a credit tightening in the relatively early stages of the crises caused by the following types of financial distress: low equity ratio; low Tier 1 capital ratio; and severe losses on financial assets. They also find that foreign banks transmit to Main Street a larger portion of similar financial shocks than domestic banks.

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