VoxEU Column Financial Regulation and Banking

The real effects of shocks to bank balance sheets: Evidence from Italy during the Great Recession

Negative shocks to bank balance sheets are problematic not just for financial markets, but for employment and economic growth more widely. This column uses evidence on a bank liquidity shock in Italy in 2007-10 to show the impact on firms’ production, investment, and employment. Firms borrowing from banks with a high exposure to the shock experienced a more intense fall both in credit flows and in investment expenditure. While the credit cut has been homogeneous across borrowers, firms with easier access to external finance were able to contain the negative consequences of the drop in credit for investment.

The 2007-2008 Global Crisis and the following Eurozone Crisis were both characterised by a sudden worsening of bank balance sheets. While negative shocks to bank health typically spur concern within financial markets (i.e. among creditors and shareholders), the large toll taken by both crises in terms of GDP and unemployment – with many countries still struggling to return to a sustained path of growth (IMF 2016, OECD 2016) – strongly suggests that they can also severely hamper ‘real’ economic activity, via the supply of credit itself.

However, the extent to which bank shocks matter for firms’ activity has not been fully established, as their consequences likely depend on a range of factors, including bank lending decisions and firms’ access to alternative (internal and external) sources of funding. Moreover, a credible quantification requires accessing detailed information on balance sheet and credit data for a large sample of firms. Recent and ongoing research dealing with this important issue and estimation challenges has focused on the impact of bank shocks on employment or investment during the recent crisis (Chodorow-Reich 2014, Bentolila et al. 2014, Balduzzi et al. 2014, Acharya et al. 2015).

In a new paper, we contribute to this literature with a comprehensive assessment of the consequences of the 2007 shock to bank liquidity in Italy, originating from the freeze of the European interbank market (Cingano et al. 2016). The study combines balance sheet data and bank-firm matched credit data (from the Italian Credit Register) for a sample of over 30,000 non-financial firms, and quantifies the effects of the shock on both the supply of credit by banks, and on the patterns of firms’ production, investment, employment, and intermediate input decisions between 2007 and 2010.

Figure 1 provides an overview of the main findings. It shows that Italian firms that, prior to the crisis, were borrowing from banks with a high exposure to the shock (i.e. banks more reliant on interbank market transactions) experienced a more intense fall both in credit flows and in investment expenditure than other firms.

Figure 1 Firms more exposed to the bank shock received less credit and cut investment more than low exposure firms, starting in 2007 

Note: The figure plots the percentage change in total credit granted relative to 2006 (left panel) and total yearly net investment as a ratio of total assets in 2001 (right panel) for firms with above- and below- median exposure to the bank shock, denoted as High ITBK/Assets and Low ITBK/Assets, respectively. See Figure 3 in Cingano et al. (2016) for further details.

Based on our estimates, these effects were sizeable. In particular, we calculate that, absent the bank shock, investment by sampled firms would have been 23.7% higher than observed in 2007-2010, implying around €28 billion of additional expenditure. Hence, the bank liquidity shock considerably aggravated the significant downturn in the investment rate (which, in the sample, fell by more than 35% relative to the pre-crisis level). We also estimate that Italian firms would have invested around 30 cents per extra euro of available credit during the first years of the Great Recession. Interestingly, this figure is similar to the sensitivity of investment to cash flow as estimated by, among others, Fazzari et al. (1988), Gilchrist and Himmelberg (1995), Bond et al. (2003), and Almeida and Campello (2007).

Looking at other firm outcomes reveals that the shock severely impacted on the purchase of intermediate goods, but had a small effect on headcount employment – contributing to just one eighth of the tiny fall observed in the sample between 2006 and 2010 (1.2%). Both figures likely reflect the fact that, in Italy, adjustments in labour input mostly occurred through a reduction in hours worked per employee. Unfortunately, hours worked are not balance sheet items.1

Eventually, the analysis shows that the 2007 bank shock can account for around half of the 5% fall in value added produced by firms in the sample up to 2010, substantially contributing to the unfolding of the Great Recession in Italy.

The analysis further qualifies the effects of a shock to bank balance sheets along a range of relevant dimensions. For example, it shows that the supply of bank credit was not influenced by firm characteristics such as age, size, or dependence on bank debt, nor by the degree of local financial development. They all faced similar cuts in credit. However, investment expenditure contracted significantly more among small, young, and highly bank-dependent firms, among firms with low liquid buffers and those located in financially underdeveloped areas (Figure 2). In other words, while the credit cut has been relatively homogeneous across borrowers, the firms with easier access to external finance or with a stronger liquidity position were able to contain the negative consequences for investment of the drop in credit.

Figure 2 The effects of the shock on investment were stronger among vulnerable firms

Note: The figure illustrates the percentage increase in the estimated impact of the bank shock on investment among selected subgroups of firms. It is based on the coefficients estimated in Table 9 of Cingano et al. (2016). Small firms have lower-than-median size. Young firms are less than 10 years old. Bank dependent firms have a higher than median share of bank debts over total debts. Cash poor firms have lower-than-median cash-holdings relative to total assets. Finally, financially underdeveloped areas are determined based on the measure of regional financial development by Guiso, Sapienza and Zingales (2004). *** , ** , and * indicate statistical significance at 1%, 5% and 10% levels of confidence, respectively.

Finally, our work suggests that high exposure firms reacted to the credit shortage by lowering trade credit to their customers, suggesting a potentially relevant amplification role of the initial shock through firms’ credit chains (Garcia and Montoriol 2013).

The severe consequences of shocks to bank liquidity on the real economy strengthen the case for a firm commitment to bolster the basis of the banking sector. We found that a high reliance on volatile sources of funding, such as interbank deposits, may have large consequences in terms of credit supply and, crucially, real outcomes such as investment, employment and value-added. These findings support the view that regulation should not only focus on bank capital but also on the liquidity and the structure of banks’ funding. 


Acharya, V, T Eisert, C Heufinger, and C Hirsch (2015), “Real effects of the sovereign debt crisis in Europe: Evidence from syndicated loans”, mimeo.

Almeida, H, and M Campello (2007), “Financial constraints, asset tangibility, and corporate investments”, Review of Financial Studies 20: 1429-60

Balduzzi, P, E Brancati and F Schiantarelli (2014), “Financial markets, banks' cost of funding, and firms' decisions: Lessons from two crises”, Working Paper 824, Boston College.

Bentolila, S, M Jansen, G Jimenez, and S Ruano (2014), “When credit dries up: Job losses in the Great Recession”, mimeo, Bank of Spain

Bond, S, J A Elston, J Mairesse, and B Mulkay (2003), “Financial factors and investment in Belgium, France, Germany, and the United Kingdom: A comparison using company panel data”, The Review of Economics and Statistics 85: 153-65

Cingano, F, F Manaresi and E Sette (2016), “Does credit crunch investment down? New Evidence on the Real Effects of the Bank-Lending Channel”, Review of Financial Studies, published online June 7

Chodorow-Reich, G (2014), “The employment effects of credit market disruptions: Firm-level evidence from the 2008-09 financial crisis”, Quarterly Journal of Economics 129: 1-59

Fazzari, S, G Hubbard, and B Petersen (1988), “Financing constraints and corporate investment”, Brookings Papers on Economic Activity 19: 141-206

Garcia-Appendini, E, and J Montoriol-Garriga (2013), “Firms as liquidity providers: Evidence from the 2007–2008 financial crisis”, Journal of Financial Economics 109: 272-291

Gilchrist, S, and C Himmelberg (1995), “Evidence on the role of cash flow for investment”, Journal of Monetary Economics 36: 541-72

Guiso, L, P Sapienza, and L Zingales (2004), “Does local financial development matter? ”, Quarterly Journal of Economics 119: 929-69

IMF (2016) World Economic Outlook: Too Slow for Too Long. Washington, April.

OECD (2016), OECD Economic Outlook, OECD Publishing, Paris


[1] In National Accounts, the number of employees in private non-agricultural industries fell by a similar amount. The number of hours worked, on the contrary, fell by 3.5%, based on National Accounts. Bank shocks have been estimated to induce more severe employment losses in the US and Spain (see, respectively, Chodorow-Reich 2014, Bentolila et al. 2014).

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