The Contagion Effect in Lending and Economic Stability: A Study of the European Sovereign-Debt Crisis and its Global Impact

This paper investigates whether a lender’s nationality and issuing currency of loans matter for the gross domestic product (GDP) growth volatility of 153 loan-receiving countries from seven major lending countries including Italian and Spanish banks in 1981-2011. The results suggest that foreign banks’ local currency credit appears to dampen a host country’s GDP growth volatility which is used to indicate economic stability (or instability). The nationality of lenders does not appear to have a significant impact on the GDP growth volatility of borrowers. Instead, the currency of loans, including switches to the Euro, is probably more important than the nationality of lenders. Specifically, the finding of the study suggests that deleveraging in Euro credit leads to a rise in a host country’s GDP growth volatility in Euro zone. Results from the contagion effect in lending and economic stability provide insights about the potential impacts of the current European Financial Crisis on the global financial markets through international credit channel.