Flooded through the Back Door : Firm-Level Effects of Banks' Capital Shifts

This paper investigates whether banks, especially those with little regulatory capital, transmit unexpected regional shocks via the banking system to otherwise unaffected firms. Combining data on significant flooding in Germans regions in 2013 with an extensive bank-firm level dataset for Germany, I identify banks exposed to the disaster via their customer relationships and then connect these banks to firms located outside of the disaster regions. I find that such indirectly disaster-exposed firms significantly reduce investment by about 8 percentage points, when compared to firms in the same region, but without a connection to a disaster-exposed bank. Importantly, banks with low capital ratios propagate the disaster shock significantly more. Firms connected to badly capitalized banks perform worse, reducing employment by 9%, highlighting that bank capital plays an important role in preventing the transmission of real shocks via the banking system