This paper examines how European banks adjusted lending at the onset of the pandemic depending on their local exposure to the COVID-19 outbreak and capitalization. Using a bank-level COVID-19 exposure measure, we show that higher exposure to COVID-19 led to a relative increase in worse-capitalized banks’ loans whereas their better-capitalized peers decreased their lending more. At the same time, only better-capitalized banks experienced a significantly larger increase in their delinquent and restructured loans. These findings are in line with the zombie lending literature that banks with low capital have an incentive to issue more loans during contraction times to help their weaker borrowers so that they can avoid loan loss recognition and write-offs on their capital.
COVID-19 and lending responses of European banks