International Lending Channel, Bank Heterogeneity and Capital Inflows (Mis)Allocation

This paper explores the role of banks’ heterogeneity in international lending and its impacts on capital inflows allocation across firms by exploiting the inclusion of South Africa into the Citi Group’s World Government Bond Index (WGBI). Using bank-level data, we provide evidence that banks holding sovereign bonds before the inclusion increase credit supply to non-financial firms after the shock. Moreover, less capitalized banks drive these effects. Using firm-level data in South Africa, we then show that credit is allocated to less financially constrained and less productive firms. We find no evidence of a significant improvement in real outcomes after the increase of credit supply to those firms. Our paper adds to the literature by analyzing the interplay between banks’ heterogeneity, capital inflows shocks and capital misallocation. We shed some light on why the international lending channel on both firms and the economy can, in certain instances, be rather limited.