Banks’ Credit Losses and Lending Dynamics

To study bank behavior, we use tail events in the history of a bank's credit losses as a new type of shock to capital. When defined appropriately, such events are virtually unpredictable for bank managers and spread evenly over time and banks. We estimate from granular data of all German banks that the heaviest losses induce banks to reduce their corporate lending by 1.79 euro for each euro lost. This sensitivity is in line with (quite heterogeneous) results of earlier studies but significantly lower than the sensitivity under a constant-leverage regime. To control for credit demand, we construct a synthetic competitor of each bank that replicates its sectoral and geographic portfolio composition. This new method combines the advantages of bank-level estimation with demand clustering at the level of granular subportfolios