Does Government Debt Affect Bank Credit?

This paper analyses 43 countries from 1970 to 2010 to investigate the effect that public debt has on bank loans. The study is motivated by the need to understand the consequences of high public debt, a condition many countries are already experiencing or will experience in the next few years. Looking at the 40-year period, we find that the ratio of government debt to GDP has a negative association with the subsequent growth of bank credit. Our results hold using different econometric methods and controlling for variables such as the lagged value of bank loans, the occurrence of banking crises, per capita GDP, the inflation rate, trade openness, international investment position, stock market capitalization and countries' legal origin.