DP5623 Banking Crises, Financial Dependence and Growth
This paper investigates the growth impact of banking crises on industries with different levels of dependence on external sources of finance to analyze the mechanisms linking financial shocks and real activity. If the banking system is the key element allowing credit constraints to be relaxed, then a sudden loss of these intermediaries in a system where such intermediaries are important should have a disproportionately contractionary impact on the sectors that flourished due to their reliance on banks. Using data from 38 developed and developing countries that experienced financial crises during the last quarter century, we find that sectors highly dependent on external finance tend to experience a substantially greater contraction of value added during a banking crisis in deeper financial systems than in countries with shallower financial systems. On average, in a country experiencing a banking crisis, a sector at the 75th percentile of external dependence and located in a country at the 75th percentile of private credit to GDP would experience a 1.6 percent greater contraction in growth in value added between the crisis and pre-crisis period than a sector at the 25th percentile of external dependence and private credit to GDP. This effect is sizeable compared with an overall mean decline in growth of 3.5 percent between these two periods. Our results, however, do not suggest that on net the externally dependent firms fare worse in deep financial systems.