Bank Lending Decision under Uncertainty: The Case of Borrowers From European Peripheral Countries in the Sovereign Debt Crisis

Abstract

The European Sovereign Debt Crisis (ESDC) spanning from 2010 to 2012 results in the biggest recession since the Global financial crisis. European countries faced high government debt, rapidly rising yield spreads in government bond, and then the collapse of several European banks. The peripheral countries, Portugal, Ireland, Italy, Greece, and Spain are arguably the most unstable hosting a vast majority of financially troubled borrowers. This paper studies the implications of spillovers from affected local banking systems to other countries which have operations in these troubled economies. Using a comprehensive interbank and international syndicated loan data sample, we find evidence on how changes in the world financial market, in particular the banking industry, alter the lending decisions of local banks. We show that bank tend to tighten their loan terms significantly during the crisis period when the perception of systematic risk changes abruptly. The tightening is also observed to be much stronger for borrowers from European peripheral countries