Do Banks Affect the Level and Composition of Industrial Volatility and How?

In theory, better access to bank credit can increase or reduce output volatility depending on whether financially constrained firms face more cash-flow or investment opportunity shocks. This paper finds that countries with high levels of bank credit have low volatility of industrial output. Most of the reduction in volatility is idiosyncratic, which follows from the ability of banks to pool and diversify shocks. Systematic volatility is also reduced, but less strongly so. Volatility dampening is achieved via counter-cyclical borrowing: at the firm level, short-term borrowing is more negatively correlated with sales in countries with high levels of bank credit