Does Sovereign Credit Risk Affect Bank Lending? Evidence from Sovereign Rating Downgrades

Abstract

We study the causal effect of bank credit rating downgrades on the supply of bank lending. The identification strategy exploits the asymmetric impact of sovereign downgrades on the ratings of banks at the sovereign bound relative to bank that are not at the bound as a result of rating agencies’ sovereign ceiling policies. This asymmetric effect leads to greater reductions in rating-sensitive funding and lending of banks at the bound relative to other banks. Results for foreign borrowers and within lender-borrower relationships confirm that credit demand does not explain our findings.