International lending channel, bank heterogeneity and capital inflows (Mis)allocation

This paper examines how heterogeneity among banks in international lending affects the allocation of capital inflows across firms, leveraging South Africa’s inclusion in the Citigroup World Government Bond Index (WGBI). Using bank-level data, we show that banks holding sovereign bonds prior to the inclusion expand their credit supply to non-financial firms following the shock, with this effect primarily driven by less capitalized banks. Using firm-level data from South Africa, we further demonstrate that the increased credit is allocated among less financially constrained and older firms, which are more likely to have established banking relationships before the inclusion. Importantly, as credit is allocated to unconstrained firms, we find little evidence of economically significant improvements in real outcomes. Our paper contributes to the literature by highlighting the interplay between banks’ heterogeneity, capital inflow shocks, and capital misallocation, shedding light on why the international lending channel may, in some instances, have a muted impact on both firms and the broader economy.