Abstract:

We develop a methodology to estimate the cross-elasticities of credit for
firms and banks, quantifying the extent of credit reallocation across relationships following
shocks. Our identification strategy leverages how not all firms borrow from all banks;
thus, indirect connections between bank-firm relationships through the credit network
provide natural exclusion restrictions. Using a simple model and Monte Carlo simulations,
we demonstrate the viability of our approach and show that neglecting reallocation can
significantly and unpredictably bias treatment and fixed-effects estimates. Applying our
estimator to twenty years of data from the Italian credit registry, we find that firms’ cross-
elasticities are negative in normal times while often becoming positive during recessions,
whereas banks’ cross-elasticities are mostly positive and uncorrelated with the business
cycle. Such evidence is consistent with the asymmetric effects of credit expansions and
contractions documented by the empirical banking literature.