Local Bank Financial Constraints and Firm Access to External Finance

This paper shows that financial constraints of local banks in emerging markets lead to underinvestment and credit constrained borrowers. I find that local bank lending is sensitive to an exogenous expansion in the availability of external financing. Using novel data to measure risk and return on marginal lending, I show that the profitability of loans does not decline during lending expansions. The resulting credit expansion leads to an increase in total borrower debt, holding investment opportunities constant. Overall, financial shocks to constrained banks are found to have a quick, persistent and amplified effect on the aggregate supply of credit.