Sovereign threat and financial institution lending: proof from 1999 Turkish earthquake

We use an exogenous fiscal shock to establish the transmission of presidency threat to financial institution lending on account of banks holding authorities bonds. We illustrate with a theoretical mannequin that for banks with increased publicity to authorities bonds, the next sovereign default threat implies decrease financial institution internet price and fewer lending. Our empirical estimates verify the mannequin’s predictions. The exogenous change in sovereign default threat of Turkish authorities debt on account of the 1999 Earthquake impacts banks whose steadiness sheets had been uncovered extra to authorities bonds. The ensuing decrease financial institution internet price interprets into decrease credit score provide. We rule out different explanations. Our estimates counsel this channel can clarify half of the decline in financial institution lending following the earthquake. This underlines the significance of the financial institution balance-sheet channel in transmitting the next sovereign default threat to decreased actual financial exercise.

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