# **1. Introduction and Motivation**

Answering the question whether firms are constrained in their growth by a lack of external financing is a complex question. It requires one to differentiate access to and usage of external financing and requires one to consider both demand and supply side factors. Some firms may not want to borrow even when they have access, relying instead on internal financing (voluntarily excluded). Some firms may want to borrow, and would in principle be able to do so, but may lack access, for example, when there is no banking outlet nearby (involuntarily excluded). Financial institutions may not want to lend to some firms because of creditworthiness concerns (credit rationing). In principle, however, the identification of firms with financing constraints can be done using rich demand and supply side data. So far, this has been mainly done for developed countries and for some developing countries where rich data were available. The issue of financing constraints is of special relevance for Brazil given its still high interest rates for some classes of borrowers, which are argued to be a constraint for growth<sup>1</sup> . However, it has been hard to separate here whether the high rates (high spreads) are due to the compensation for borrowers’ risks and other weaknesses on the demand side, or due to supply constraints, at the level of individual financial institutions (e.g., lack of competition among banks), inefficiencies in financial intermediation (e.g., lack of credit information, financial taxation, etc.), a weak contracting environment due to judicial inefficiencies, or other factors.

Over the past decade Brazil has come a long way in terms of market deepening. Spreads have also come down significantly for households and considerably for firms. This paper presents a simple way to do financing constraint analysis of the impact of interest rates on the demand and supply of bank credit to micro, small and medium firms using a rich dataset including not publicly available firm level transaction data from the Credit Registry System of the Central bank, firm characteristics data from the ICA (Investment Climate Assessment) firm survey and banks characteristics data from the Central Bank. This survey provides detailed information on firms’ characteristics as well as their perception of the business environment and is an important tool in World Bank business environment and financial intermediation analyses. The paper is able to reconcile at the firm level the ICA information with privately available credit registry data from the Central Bank for almost a decade allowing us to have a view at both the bank relationships of the firms at the system level over time as well as the very minute details of who they are at two specific points in time in 2004 and four years later in 2008. This is the first dataset to our knowledge that can have that detailed level of information on these different aspects. We are able to complete the database on the banks using publicly available bank information from the Central Bank over time. The ICA and the bank registry data have not been used for that purpose before to our knowledge, but we argue that by using the uniqueness of bank-firm lending relationships, they provide the ability to separate demand from supply factors.

Previous papers using bank registry data have focused only on the information provided to the bank. For instance, some have just focused on one type of credit instrument. Jimenez, Lopez, Saurina (2009) investigate the determinants of the usage of bank credit lines using a database of Spanish corporate credit lines and find that bank monitoring affects firm’s usage of the line as firms with prior default access their credit lines less. Their paper investigates how the relationship between the use of collateral and the credit risk of the borrower plays out in different segments of the credit market (short term and long term loans, new and old borrowers). Khwaja and Mian (2005) use loan level data for the universe of corporate lending in Pakistan and find that politically connected firms have preferential access to public banks loans in Pakistan. Khwaja and Mian (2008) use data that allows them to follow how bank liquidity shocks are passed on to firms and how large firms can compensate for this loss through credit markets whereas small firms are unable to do so and face large drops in overall borrowing. Ioannidou, Ongena, Peydro (2009) use data from the Bolivian Credit Registry database (CIRC) to investigate the impact of monetary policy – as measured by an exogenous increase of the Fed funds rate in a fully dollarized banking system whose economy is not synchronized to the US economy **–** on bank risk

> 1 See Haussman, Rodrik, and Velasco (2005) who argue that the Brazilian economy does not lack profitable investment opportunities but the high opportunity cost of capital means few new investments are profitable enough in order to overcome this hurdle.

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