We study the effect of the increase in Italian sovereign debt risk on credit supply on a sample of 670,000 bank-firm relationships between December 2010 and December 2011, drawn from the Italian Central Credit Register. To identify a causal link, we exploit the lower impact of sovereign risk on foreign banks operating in Italy than on domestic banks. We study firms borrowing from at least two banks and include firm x period fixed effects in all regressions to controlling for unobserved firm heterogeneity. We find that Italian banks tightened credit supply: the lending of Italian banks grew by about 3 percentage points less than that of foreign banks, and their interest rates were 15-20 basis points higher, after the outbreak of the sovereign debt crisis. We test robustness by splitting foreign banks into branches and subsidiaries, and then examine whether selected bank characteristics may have amplified or mitigated the impact. We also study the extensive margin of credit, analyzing banks' propensity to terminate existing relationships and to grant new loan applications. Finally, we test whether firms were able to compensate for the reduction of credit from Italian banks by borrowing more from foreign banks. We find that this was not the case, so that the sovereign crisis had an aggregate impact on credit supply.
Published in 2018 in: Journal of the European Economic Association, v.16, 3, pp. 696-729