# **2.1 The Labor Market Channel**

The primary channel through which banking crises are likely to impact households is through the labor market – as the result of a credit crunch in the corporate sector. Credit losses and losses on non-loan assets erode bank capital limiting their provision of credit to the firms. The extension of credit may further be constrained as the availability of funding dries up or the cost of funding increases when wholesale and retail creditors exert market discipline on banks (Martinez Peria and Schmukler, 2001).<sup>3</sup> Whether the reduced lending by some banks may lead to a widespread credit crunch in the corporate sector depends on firms’ banking relationships. Even a reduction in lending by large, systemically important banks may not lead to a credit crunch if firms can replace this funding with loans from other banks.<sup>4</sup> Firms are most likely to be insulated from lending stops by specific banks when they maintain multiple bank relationships (Gobbi and Sette 2012). As suggested by the literature on the financial accelerator and the credit channel of monetary policy see e.g. Bernanke and Gertler 1995) the impact of banking crises on access to credit will strongly depend on the firms balance sheets as well: Those firms and sectors with strong equity positions are less likely to be constrained, while firms or sectors which experience a deterioration of their balance sheets in the crisis are mostly likely to be hit by a credit crunch (Jimenez et al. 2012).

A credit crunch in the corporate sector can trigger a reduction in production and investment, leading to reduced employment and wages. Evidence from financial crises in the 1990’s suggests that credit crunches are most likely to affect labor demand in the construction and manufacturing sectors (Fallon & Lucas 2002). When banking crises lead to currency crises they further lead to sectoral changes in labor demand: Employment in export-orientated sectors (e.g. commodities, agriculture) are boosted, while labor demand in manufacturing sectors that rely on imported inputs decreases. Evidence from Indonesia during the East Asian Crisis shows, for example, that agricultural employment rose by 13% in 1998 while employment in the manufacturing sector fell by 10%. Fallon and Lucas (2002) report similar sectoral shifts in employment for Korea, Malaysia and Thailand during that period.

> 3 Han and Melecky (2013) show that bank’s access to deposit funding in crisis times may depend on the degree of financial inclusion in a country. They show that countries with a broader use of deposit accounts experienced a weaker slowdown in deposit growth between 2006 and 2010.

> 4 Alternatively, capital market funding or trade credit may cushion a bank-credit crunch on the corporate sector. De Haas and Van Horen (2013) document that financial crises are associated with a sudden stop in cross-border syndicated lending to large enterprises in emerging markets. This suggests that commercial (international) financial markets may hardly provide emergency funding to firms hit by domestic credit crunches. Garcia-Appendini and Montirol-Garriga (2013) show that trade credit replaced bank-credit as a source of liquidity for large US firms during the Great Recession.

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