Lending Standards Over the Credit Cycle

We exploit an institutional feature of the Italian credit market that generates a discontinuity in the allocation of comparable rms into the performing and substandard classes of credit risk. In boom, segmentation results in a positive interest rate spread between substandard and performing rms. In bust, the increase in the banks' cost of wholesale funds implies that substandard rms are excluded from credit. These rms then report lower values of production and capital investments.