Lending Relationships and the Effect of Bank Distress: Evidence from the 2007-2008 Financial Crisis

We study the role of lending relationships in the transmission of bank distress to the real economy. We use the 2007-2008 financial crisis as a laboratory and study a sample of publicly traded firms from 34 countries and a large set of bank loans. We examine the effect of both bank-specific shocks to the financial health of banks (announcements of bank asset write-downs) and systemic shocks (the failure of Bear Stearns and Lehman Brothers) that produced heterogeneous effects across banks. We find that bank distress, as captured by equity valuation losses, is associated with valuation losses to borrower firms that have lending relationships with banks. The effect is concentrated in firms with the strongest lending relationships, the greatest information asymmetry (e.g., smallest firms and firms with the least analyst coverage) and the weakest financial position at the time of the shock (e.g., firms that needed to roll over the largest part of their debt during the shock). Overall, our findings suggest that the loss in the value of lending relationships represents an important channel through which bank distress imposes costs on the real economy.