This paper analyzes the effect of unpredictable aggregate shocks on loan demand and access to credit by combining client-level information from an Ecuadorian microfinance institution with geophysical data on natural disasters, more specifically volcanic eruptions. The results of this ‘natural experiment’ show that while credit demand increases due to volcanic activity, access to credit is restricted. Yet, we also find that bank-borrower relationships can lower these lending restrictions and that clients who are known to the institution are about equally likely to receive loans after volcanic eruptions occurred.

Abstract We analyze how banks adjust their lending to small firms after distinct shocks from the cross-border transmission of the 2007–09 crisis by using unique loan application and contract data from AccessBank Azerbaijan. These data allow us to disentangle the effects of a funding shock from the effects of a real shock. Contrary to conventional assumptions, we find that the funding shock works through reduced prospecting—as opposed to tightened lending standards—and leads to fewer loan applications among new applicants in particular, which improves the borrower pool. The real economy shock instead works through loan approval and affects small and medium enterprise rather than micro borrowers.