Are idiosyncratic shocks to one industry transmitted to other industries through common financial intermediaries? In this paper, we find that when banks are exposed to shocks due to their specialization in a certain sector, then they are more likely to increase lending to the treated sector due to a higher compensation. In addition, we find that banks cut their lending disproportionally in unrelated and non-affected sectors due to the bank’s funding capacity. At the aggregate-industry level, the effects are attenuated during good times as firms raise financing from other banks or from other markets or use internal funds. We do not find these shocks to have any effect on unrelated industries in good times or any associated real effects. However, during bad times, or when financing conditions are tight, these shocks translate into real effects for unrelated industries and thus highlight that idiosyncratic shocks to industries can be passed on to other unrelated industries through common lenders when times are bad and thus amplifying the initial shock. Critically, bank linkages between (unrelated) sectors serve as the transmission channel for the pass-through of industry externalities.

Date: 18 March 2021



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