We use loan-level data and a novel identification setting – closures of banks – to study how forced break-ups of lending relationships affect firms’ borrowing costs. We find that after a financially distressed bank closed and its best borrowers were exogenously forced to switch, their borrowing costs dropped steeply and converged to the market’s average. We document no such effect when a healthy bank closed. This suggests that distressed banks can use informational monopoly power to hold up and exploit their best borrowers. Apparently, closures of such banks can release the best-quality firms from the hold-up and allow borrowing cheaper elsewhere.
JEL Codes: D82, E51, G20, G21, G30, G33, L14.
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