Estimating the Effects of Informational Frictions on Credit Reallocation

Abstract

This paper introduces a novel empirical approach to study the role of an informational friction limiting the reallocation of credit after a shock to banks. Because lenders use their private information about their borrowers when deciding which relationship to end, borrowers left looking for a new lender are adversely selected. To quantify the effects of this friction on aggregate lending, I develop an econometric model of relationships with three layers of information: (i) all lenders have some information about borrowers, but (ii) each lender has private information about its existing borrowers, and (iii) the econometrician observes neither. I show how to use bank shocks to identify this private information separately from information common to all lenders. I apply this approach to the U.S. corporate loan market during the crisis and find that the probability that a firm finds a new lender after a breakup would be 30% higher if there were no private information. At the aggregate level, $14 billion new loans were not made because of this friction. Moreover, interventions supporting weak lenders exacerbate adverse selection and this equilibrium effect reduces their effectiveness.