Foreign Lenders and the Real Sector


  • 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.


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.