Description:

Speaker: Ashagrie Demile Moges (CEGA fellow)

Title: Liquidity shock and bank lending: Evidence from a natural experiment in Ethiopia

Abstract: This paper provides new evidence on the lending channel of liquidity shock by exploiting the mandatory regulatory requirement in the least developing country, Ethiopia. The result from the difference-in-difference strategy using bank's balance sheet data shows that the policy change had an immediate and stronger negative effect on the bank's most liquid asset, cash on hand,  on banks that are larger and more liquid, and persisted for quite some time. The same estimation strategy using the loan-level data also reveals that the liquidity shock propagated to the bank's loan supply five months after the implementation of the regulation. The result is robust after controlling for the possible difference in credit demand by sectors, regions, and borrower types that banks face. The study further indicates that banks' response to the liquidity shock varies by borrowers’ industries suggesting that banks adjust their loan portfolio towards less risky loans.