Nº 20-07: Flooded Through the Back Door: The Role of Bank Capital in Local Shock Spillovers

This paper demonstrates that low bank capital carries a negative externality because it amplifies local shock spillovers. We exploit a natural disaster that is transmitted to firms in non-disaster areas via their banks. Firms connected to a strongly disaster-exposed bank with lowest-quartile capitalization significantly reduce total borrowing by 4.8%, employment by 2.7% and tangible assets by 7.5% compared to similar firms connected to a well-capitalized bank. These findings translate to negative regional effects on GDP and unemployment. Banks also particularly reduce their exposure to this-time-unaffected but in general disaster-prone areas following a disaster.