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Diana Bonfim is a senior economist in the Financial Intermediation Division of the Economics and Research Department of Banco de Portugal, where she works since 2001, and a visiting associate professor at Católica Lisbon School of Business and Economics. Diana holds a Ph.D in Economics from University of Groningen, Netherlands (2014). She’s President-Elect of IBEFA and a member of Prosper and of the Center for Banking and Finance Research. Her research interests comprise empirical banking, corporate finance, and the transmission of monetary policy. She has published in the Review of Finance, Journal of Financial Intermediation, Journal of Banking and Finance, among others.
We show that banks’ lending exposure to firms with government procurement contracts can amplify the diabolic loop between sovereigns and banks. Using the fiscal austerity measures implemented during the 2010-2011 European sovereign debt crisis as a shock to government procurement, we find that banks with higher exposure to these firms reduced lending significantly more than banks with lower exposure, controlling for firm-specific credit demand. The reduction in credit supply is economically as important as the effect of banks’ sovereign debt holdings, and affected both firms with and without government contracts. Firms with lending relationships with affected banks experienced lower sales growth, assets growth, employment growth, and investment. This decrease in real economic activity is likely to reduce tax revenue, further amplifying the diabolic loop.