Bank risk-taking and a firm's default risk

In this paper, we explore the relation between the banking sector’s risk-taking (hereafter “bank risk-taking”) and a firm’s investment and default risk. We develop a simple one-period model with multiple firms and banks that analyzes a firm’s investment subject to a bank’s lending decision (risk-taking). We theoretically examine the effect of a change in the bank’s risk-taking on a firm’s investment and default risk. We empirically test whether an increase in bank risk-taking is positively associated with a firm’s investment and default risk using a sample of publicly listed firms in Japan during 2000-2020 (2,106 firms and 31,926 firm-year observations). Our results indicate that after controlling for the level of bank risk-taking, the change in bank risk-taking is positively associated with a firm’s investment and default risk.