SOGEI website background

Capital Inflows, Sovereign Debt and Bank Lending: Micro-Evidence from an Emerging Market

This paper uses a quasi-natural experiment to show that government access to foreign funding increases private access to credit. I identify a sudden, unanticipated and exogenous increase in capital inflows to the sovereign debt market in Colombia. This was due to J.P. Morgan’s inclusion of Colombian bonds into its emerging markets local currency government debt index, which led to an increase in the share of sovereign debt held by foreigners from 8.5 to 19 percent. This event had significant and heterogeneous effects on Colombia’s commercial banks: banks that acted as market makers in the treasury market reduced their sovereign debt holdings by 4.2 percentage points of assets and increased their commercial credit supply by 3.9 percentage points of assets compared to the rest of the banks. The differential increase in credit is around 2 percent of GDP. Firm and industry level evidence suggests that this had positive effects on the real economy. A higher exposure to market makers led to a higher growth in financial debt, investments, employment, production and sales.