Cross-Border Banking And The International Transmission Of Financial Distress

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.