Uncertainty, credit and investment: Evidence from firm-bank matched data

This paper studies how high uncertainty affects corporate bank loans, addressing the important issue of identification. In times of high uncertainty, firms reduce their credit demand due to delayed investments or a deterioration in credit worthiness. Simultaneously, banks are more exposed to negative shocks to their balance sheet, reducing credit supply. To isolate the uncertainty effect from the credit supply effect, we employ matched bank-firm loan data covering all loans extended by all financial intermediaries to listed firms in Korea, a bank-centered economy. Our empirical results reveal that a failure to control for credit supply leads to overestimating the effect of uncertainty on bank loans. In terms of the transmission channel of uncertainty, we find the evidence of both the real option channel and the financial channel: the negative effect is stronger for firms with a higher degree of investment irreversibility and financially constrained firms. In addition, our findings suggest that larger firms may be predominantly affected by uncertainty shocks through the real option channel rather than the financial channel. In addition, our empirical findings on firm investments align with those on bank loans.