Posted by Ross Levine, University of California, Berkeley, on
Thursday, May 5, 2016
Ross Levine is Professor of Finance at the University of California, Berkeley. This post is based on an article authored by Professor Levine; Chen Lin, Professor of Finance at the University of Hong Kong; and Wensi Xie, Assistant Professor of Finance at the Chinese University of Hong Kong.
Although banking crises are costly, common, and heavily researched, there is surprisingly little research on corporate resilience to systemic banking crises. In an earlier paper, [1] we showed that strong shareholder protection laws mitigate the adverse effects of banking crises by easing the ability of firms to issue equity when crises curtail the flow of bank credit to firms. But, other factors might also shape the ability of corporations to obtain financing during systemic banking crises.
In our new paper, Corporate Resilience to Banking Crises: The Roles of Trust and Trade Credit, which was recently made publicly available on SSRN, we examine whether social trust affects (a) the ability of firms to obtain financing through informal channels when crises reduce the flow of bank loans to firms and (b) the resilience of corporate profits and employment to systemic banking crises. Social trust refers to the expectations within a community that people will behave in honest and cooperative ways and the extent to which human interactions are governed by the norms of reciprocity and trustworthiness. Informal finance refers to short-term credit provision that occurs beyond the scope of a country’s formal financial and regulatory institutions. For example, firms often receive trade credit that does not involve collateral or promissory notes subject to formal judicial enforcement mechanisms. In communities where individuals are more confident that others will repay them—even when there are no formal enforcement mechanisms underpinning the extension of credit, trade credit is likely to flourish. Thus, when a systemic banking crisis impedes the normal bank-lending channel, social trust might facilitate corporate access to trade credit and partially offset the adverse effects of the crisis on corporate profits and employment. This could be the first-order effect since trade credit is large. It accounts for 25% of the average firm’s total debt liabilities in our sample of over 3500 firms across 34 countries from 1990 to 2011.
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