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To establish this causal chain, they rely both on a natural experiment that induces exogenous variation in banks’ capital adequacy and the ability to identify where banks are underreporting incurred loan losses.
The richness of their data allows them to trace how the heightened credit misallocation translates into heightened misallocation of factor inputs which in turn drags down aggregate productivity growth. While they exploit a relatively short lived regulatory intervention to cleanly identify the costs of a weak banking sector, the causal mechanism they identify in this paper is likely to apply beyond the period authors study.
Authors show that the underreporting of loan losses is pervasive both in the lead-up to the regulatory intervention they study and in the years following the intervention.
Their results highlight the importance of understanding the effect of supply side frictions in credit markets on the composition of credit, especially in economies where banks play a key role in allocating resources to firms. They show that in such bank-dependent economies the (mis)allocation of credit feeds through to the (mis)allocation of production factors.
Authors show that, at least in partial equilibrium, this channel can have a significant impact on aggregate productivity growth. Further quantifying the impact of this causal channel on aggregate productivity is a fruitful avenue for future research.