Financial markets, banks' cost of funding, and firms' decisions : lessons from two crises

We test whether adverse changes to banks' market valuations during the financial and sovereign debt crises, and the associated increase in banks'cost of funding, affected firms' real decisions. Using new data linking over 3,000 non-financial Italian firms to their bank(s), we find that increases in banks' CDS spreads, and decreases in their equity valuations, resulted in lower investment, employment, and bank debt for younger and smaller firms. Importantly, these effects dominate those of banks' balance-sheet variables. We also show that higher CDS spreads led to lower aggregate investment, employment, and a less efficient resource allocation.