Publication:

Banking stability, competition, and economic volatility

The paper analyzes the influence of banking stability on the volatility of industrial value added and how it varies across 110 countries depending on bank market competition and bank-firm relationships. We find that banking stability reduces the volatility of value added more in industries that have greater external dependence and intangible intensity when they are located in countries with more developed financial systems and better investor protection. These results are consistent with the relevance of a lending channel and an asset allocation channel such as the channels through which banking stability diminishes industrial economic volatility. Moreover, we find that banking stability helps reduce economic volatility more, through both channels, in countries that have less bank market competition or close bank-firm relationships. We use several proxies for banking stability and control for countries’ banking development, reverse causality problems, and endogeneity of banking stability.