Abstract
How does a bank react when a substantial share of its borrowers suffer a large negative shock? To answer this question we exploit the 2014 collapse of energy prices using the universe of Mexican commercial bank loans. We show that, after the drop in energy prices, banks exposed to the energy sector increased their exposure to these borrowers even more, relaxing credit margins to their larger debtors in the sector. An increase of one standard deviation in a bank's ex-ante exposure to the energy sector increased the loan volume to borrowers in the sector by 18 percent and reduced interest rates by 6 percent, even though borrower's credit default swap spreads were widening. Highly exposed banks amplified this sector-specific shock to the rest of the economy by contracting lending to other sectors, with important real effects, as the borrowers could not switch credit suppliers. Finally, the energy price shock had a large negative impact on macro outcomes, especially in the capital-intensive secondary sector. Quantitatively, a one standard deviation increase in the exposure of a state's banks to the energy sector reduced its GDP by 1.8 percent.
Highlights
Risk concentration has been a driver of major banking crises around the world (Acharya and Steffen 2015; Brunnermeier 2009; Westernhagen et al 2004), forcing regulators to continuously monitor bank exposures to concentrated risks (FSI 2019)
At a more aggregate level, we find that, compared with energy-producing states, the gross domestic product (GDP) of non-energy-producing states that were more exposed to the energy sector contracted more during the energy price shock, especially in the capital-intensive secondary sector (Buera, Kaboski, and Shin 2011)
We find that the sharp drop in energy prices had a substantially greater effect on banks with higher ex-ante exposure to the energy sector
Summary
Risk concentration has been a driver of major banking crises around the world (Acharya and Steffen 2015; Brunnermeier 2009; Westernhagen et al 2004), forcing regulators to continuously monitor bank exposures to concentrated risks (FSI 2019). More exposed banks may be forced to expand their lending to the struggling sector, especially to their largest borrowers, to contain losses and preserve their regulatory capital ratios. In this latter scenario, risk concentration may trigger a credit channel whereby banks inject even more credit to borrowers in a troubled industry, reducing credit to other sectors in the economy. Risk concentration may trigger a credit channel whereby banks inject even more credit to borrowers in a troubled industry, reducing credit to other sectors in the economy This leads to a misallocation of resources away from productive borrowers, and raises the risk of financial stress, given the increased concentration in a weak segment of the economy
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