The Impact of a Higher Cost of Credit on Exporters: Evidence from a Change in Banking Regulation

Abstract

How do exporting firms react to changes in the cost of credit? To answer this question, we exploit an exogenous variation in banking regulation which increases the cost of financing for exports in the European Union. Using a unique dataset which combines customs, firm-level, and credit registry data on Portuguese firms we find that in response to an increase in the cost of credit, exports fall by 10 percent through the intensive margin. In the extensive margin, we also show that there is a sharp drop in entry as well as an increase in firm exit. Within a firm, we document that firms reduce their dependence on bank credit by adjusting their product mix, as firms shift towards products with a low dependence on working capital and bank credit. We also provide direct evidence of the mechanism through which the change in banking regulation operates. We find that loan rates for exporting firms increase and that loan amounts fall by 7 percent. We then turn to aggregate trade data for all E.U. countries. We find that there is an overall decline in exports, but that this decline is driven by countries with undercapitalized banks or where bank equity is scarce. This finding suggests that the health of the banking system is an important determinant of how exports react to an increase in the cost of credit. Using a multi-sector Ricardian model, we show that welfare in E.U. countries declines due to a depreciation in terms of trade. Welfare in countries which import goods from the E.U. also declines.