Loan Guarantees, Bank Lending and Credit Risk Reallocation

How do government loan guarantees reallocate bank lending and credit risk? Using unique euro-area credit register data and exploiting the COVID-19 loan guarantee programs as a laboratory, we establish two main findings. First, guaranteed loans were mostly extended to small but creditworthy firms in sectors severely affected by the pandemic, borrowing from larger and stronger banks. Second, guaranteed loans partially substituted for pre-existing debt. Banks extending guaranteed loans reduced non-guaranteed credit by about 40% more than other banks lending to the same firm. Substitution was highest for riskier and smaller firms in more affected sectors, and for stronger banks.