Financial Markets, BanksÕ Cost of Funding, and FirmsÕ Decisions: Lessons from Two Crises

We test whether financial fluctuations affect firmsÕ decisions through their impact on banksÕ cost of funding. We exploit two shocks to Italian banksÕ CDS spreads and equity valuations: the 2007Ð 2009 financial crisis and the 2010Ð2012 sovereign debt crisis. Using newly available data linking over 3,000, mostly privately held, non-financial firms to their bank(s), we find that increases in banksÕ CDS spreads, and decreases in their equity valuations, lead younger and smaller firms to cut investment, employment, and borrowing. We conclude that financial market fluctuations affect even private firms through their banksÕ cost of funding.