Local Bank Financial Constraints and Firm Access to External Finance

Measuring the extent and consequences of financing frictions among local banks isparticularly relevant in emerging markets. In first place, financial constraints are more likely tobe prevalent among local banks, since unlike large foreign banks, these do not have largeinternal capital markets from which to draw funding (Berger, Klapper, Miller and Udell (2003),Stein (1997)). Also, recent evidence suggests that borrowers of local banks may have little accessto other sources of funding even when banking markets are open to foreign investment (Mian(2006)). As a consequence, shocks to the banking sector can have a disproportionate effect oninvestment by local bank borrowers in emerging markets.The macroeconomic environment in Argentina during the late 90s is particularly suitable forstudying bank liquidity issues. The banking system was operating amidst increasing liquidity andstalling investment opportunities. Real GDP grew at an annual average of 0.1% between 1998and 2000, while total bank deposits experienced an average yearly growth of 9.1% during thesame period. These conditions stack the cards against finding evidence of banks beingconstrained in the resources available for investment.B. Testing for Financing Constraints of BanksThe empirical literature on the lending channel is focused on providing evidence of thefailure of the Modigliani-Miller (MM) proposition for banks: changes in the financial position ofan unconstrained bank will not affect its lending behavior. The usual empirical specificationlooks at the relationship between loan growth and variables that affect bank sources of capital:lnL it - lnL it-1 = α i + α t + β 0 (lnD it - lnD it-1 ) + γx it + ε it(I-1)where L it are total loans of bank i at month t, D it is a proxy for sources of capital net of reserverequirements, α i (α t ) are bank (month) fixed effects, x it is a set of controls and ε it is a stochasticerror term. Under the null hypothesis of no financial frictions, β 0 =0. Changes in sources of7