Relationship Networks in Banking Around a Sovereign Default and Currency Crisis

Abstract: We study how banks' exposure to a sovereign default and a sharp currency devaluation gets transmitted onto the corporate non-financial sector.  To do so we use a proprietary dataset for the universe of banks and firms in Argentina during the crisis of 2001. We proceed in three steps. First, we exploit the variation in the data at the bank level to show that there is a negative correlation between banks' pre-crisis exposure to sovereign debt and foreign currency liabilities and their post-crisis lending. Second, we build a model characterized by matching frictions in which firms establish (long-term) relationships with banks that are subject to balance sheet disruptions and derive a set of testable implications. Credit relationships with banks more exposed to the crisis suffer the most (independent of the state of the borrower). However, this relationship-level effect might overstate the true cost of the crisis.  After the shock, firms with investment opportunities (e.g., exporters after a devaluation) might find it profitable to switch lenders, reducing the negative impact on overall credit and activity.  Finally, we use linked bank-firm data and data aggregated to the firm level to test the predictions of the model.  We find evidence largely consistent with our theory.