Unnatural Selection At Work: An Analysis of Bank-Firm Relationships in Italy After

We analyze the eects of the …nancial crisis on credit supply, by using highly detailed data on bank-…rm relationships in Italy after Lehman's bankruptcy. We control for demand by using …rm-speci…c …xed eects. We …nd evidence of credit crunch; namely, we document a contraction of credit supply associated to low bank capitalization. Furthermore, and more importantly, we provide evidence of unnatural selection in credit allocation. Under-capitalized banks may have an incentive to allocate credit to impaired borrowers, in order to avoid the realization of losses on their balance sheets. We propose new meth- ods to identify impaired borrowers, based on the lending pattern of …nancially sound banks, or on the …rms'economic fundamentals as proxied by productivity level, or a combination of both. The evidence of 'evergreening'behavior that we …nd is very robust across identi…ca- tion methods and model speci…cations. It is the …rst evidence of this type beyond that supplied for the Japanese crisis of the nineties. � This is a …rst preliminary draft, not to be circulated. The views in this paper are those of the authors only and do not necessarily re‡ect those of the Bank of Italy. At an early stage of our research, helpful comments and suggestions were received from partic- ipants at a seminar at the Bank of Italy, Department for Economic Outlook and Mone- tary Policy Studies. Of course, responsibility for any errors is entirely our own. E-mail: ugo.albertazzi@bancaditalia.it; domenico.marchetti@bancaditalia.it.