Relationship Banking, Network Dynamics and Sovereign Default

We study the impact of banks' exposure to defaulted sovereign debt on their supply of credit. As a natural experiment and to identify the credit supply effects of an unanticipated shock to banks funding, we use the default of 2001 in Argentina and the sharp currency devaluation that followed. We start by exploiting the variation in the data at the bank-level and bank-firm linked data in the context of a reduced form empirical model. Then, we build a model characterized by search and matching frictions in which firms (borrowers) develop long-term relationships with their lenders. Using bank-firm linked data for the period 2001-2005 we find evidence consistent with our theory. Exposure to defaulted bonds in 2001 of the lenders that a firm borrows from has a negative effect on the post-default growth rate of the supply of credit available to that firm. This exposure effect is weaker for firms that were able to grow even after the default.