ECB paper links bank credit shocks to firm investment dynamics

A new European Central Bank working paper, utilizing the AnaCredit database and the Amiti and Weinstein (2018) methodology, investigates how credit supply shocks influence firm-level investment across the euro area.

The study decomposes loan growth into bank-specific, firm-specific, industry-specific, and common shocks.

Findings reveal that idiosyncratic bank supply shocks significantly impact firm-level investment, especially for firms highly dependent on bank loans.

Smaller and younger firms, often lacking alternative funding sources like bonds or internal cash, are particularly vulnerable.

Conversely, larger firms with diversified financial resources show less sensitivity.

The research also highlights that negative bank shocks exert a disproportionately larger negative effect on investment.

At the macroeconomic level, firm-specific and bank-specific shocks are identified as key drivers of aggregate credit fluctuations, supporting the "financial accelerator" theory.

The study builds on existing literature that emphasizes the critical role of financial frictions and credit constraints in amplifying economic shocks and influencing monetary policy transmission.

A significant challenge in this field is distinguishing between credit supply and demand shocks, given their endogenous connection with firm performance.

The paper employs an extended Amiti and Weinstein (2018) methodology.

This approach uses a variance decomposition framework to identify granular bank-level supply shocks without relying on instrumental variables, providing a comprehensive breakdown of loan growth rates.

This method links micro-identification to macro-aggregates, offering valuable insights into how these shocks propagate.

Previous research has shown that credit supply contractions negatively impact the real economy, especially for borrowers without alternative funding sources.