Banks, non-bank funding sources and the allocation of credit to firms

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  • On the 1st of December, Saara Tuuli will defend her thesis “Banks, non-banks and the allocation of credit to firms”. The thesis consists of three essays, which cover the impact of capital reform on firms’ credit conditions, the economic impact of shocks to credit conditions and hypotheses over the misallocation of capital towards unproductive uses.

    The first essay considers the extent to which the credit conditions of firms exposed to Basel II capital reform through their main banking relationship differed from those unexposed to the reform. A key finding is that exposed firms faced a much higher likelihood of facing credit constraints over 2007-2010, particularly when the sample is adjusted for the demand by firms for bank credit. The deterioration is found to mostly come in the form of an increase in the cost of credit (margins and fees) and, to a lesser extent, the volume of lending (including loan maturity). At least three-quarters of the difference is attributed to the procyclicality of capital regulation under Basel II, while the results also suggest that banks shifted their portfolios towards low-risk assets and away from riskier customers.

    The second essay considers the impact of changes in credit conditions on real economy outcomes. Using an instrumental variable estimation approach, the key finding is that, with the exception of employment, credit constraints played little role in firms' decisions and in turn, the GDP contraction in Finland 2009. The results are consistent with anecdotal evidence of Finnish firms being heavily affected by the collapse in global demand, with funding conditions remaining relatively unaffected particularly compared to many other European countries. Evidence of a relationship between a deterioration in credit conditions and a decline in employment makes intuitive sense: payroll is met with working capital and hence cash flow issues are likely to influence hiring and firing decisions, particularly in the context of predetermined collective bargaining agreements.

    The third essay considers zombie firms --- that is, mature, unprofitable firms that remain in the market -- and their funding sources. The literature has emphasised the role of bank funding as the main reason for zombie survival, with this conclusion being made despite no comparative analysis of the sources of external finance for zombie firms. The third essay provides the first analysis of that sort using Finnish data. The results find a key role for owners (i.e. equity funders) in keeping zombies alive in the (often correct) anticipation of the firm recovering. This result is robust to various measurement and specification issues. Although funding by banks is found to be associated with an increase in zombie lifetime, equity funding and public funding sources are found to decrease the exit rate out of zombie status by substantially more than banks.

    Saara Tuuli