Nº 20-50: The Perceived Costs of Armed Conflict

We study how banks respond when their borrowers and loan officers are exposed to armed conflict. We find that affected branches raise interest rates while loan amounts, maturity, internal risk ratings, realized default, and collateral requirements do not change. The response is strongest immediately after and subsequently fades with time. A structural model of credit demand, default, and supply attributes the remaining pricing wedge to perceived default risk. Our counterfactual estimates depict that in the absence of conflict, interest rates would be 29 bps lower demonstrating that the perceived cost of conflict is embedded in credit prices.