Foreign Lenders and the Real Sector

Authors


  • We wish to thank Heski Bar-Isaac, Alberto Bennardo, Matteo Iacoviello, Nobuhiro Kiyotaki, John Moore, Marco Pagano, Rowena Pecchenino, Michele Piccione, and seminar participants at Ente Einaudi/Bank of Italy, London School of Economics, Michigan State University, University of Salerno (CSEF), and University of Warwick for helpful comments and discussions. All remaining errors are ours.

Abstract

We develop a theory of the interaction between the entry of lenders and the real sector. The high liquidation skills of incumbent lenders render them too tough in terminating high-risk/return projects. Being “foreign” to the market, newcomers have lower ability to liquidate than incumbents. This makes them softer in liquidating high-risk/return projects but renders their funding more costly. We show that the entry of lenders and the share of high-risk/return projects can reinforce each other through firms' liquidation values. This interaction dampens the output impact of liquidity shocks. Hence, financial liberalization can enhance stability.

Ancillary