Using novel monthly data for 226 euro-area banks from 2007 to 2015, we investigate the determinants of banks’ sovereign exposures and their effects on lending during and after the crisis. Public, bailed-out and poorly capitalized banks responded to sovereign stress by purchasing domestic public debt more than other banks, consistent with both the “moral suasion” and the “carry trade” hypothesis. Public banks’ purchases grew especially in coincidence with the largest ECB liquidity injections, which therefore reinforced the “moral suasion” mechanism. Bank exposures significantly amplified the impact of sovereign stress on bank lending to domestic firms, as well as on lending by foreign subsidiaries of stressed-country banks to firms in non-stressed countries. Altogether, our evidence connects this amplification effect and its cross-border transmission to the moral suasion exerted by domestic governments on banks during the crisis.

We document that the reallocation of central bank reserves towards banks with higher liquidity needs fosters credit supply. Exploiting the ECB's tiered reserve remuneration system for identification, we show that this system encouraged banks with low reserve holdings to obtain more reserves through the money market. Concomitantly, these banks reduced their securities holdings and extended more credit. We estimate that the reallocation of one euro of reserves towards banks with ex ante low reserve holdings resulted in an increase in credit supply of about 15 cents.

Exploiting confidential data from the euro area, we show that sound banks pass negative rates on to their corporate depositors and that pass-through is not impaired when policy rates move into negative territory. We do not observe a contraction in deposits, reflecting a general increase in corporate liquidity during the sample period. When their banks charge negative rates on deposits, firms with ex ante high liquidity invest more than comparable firms that are not charged negative rates and increase their liquid holdings less. These results challenge the common view that conventional monetary policy becomes ineffective at the zero lower bound.

Do banks extending government-guaranteed loans simultaneously reduce their risk exposure to firms? Using unique euro-area credit register data and the COVID-19 guarantee programs as a laboratory, we find that 1 euro of guaranteed lending was associated with a reduction of 28 cents in non-guaranteed credit, relative to other banks lending to the same firm. Substitution was highest for riskier and smaller firms in more affected sectors and for stronger banks. Nevertheless, banks offered cheaper credit and longer maturities to guaranteed loan recipients, especially more fragile ones. This improvement in lending terms is the flipside of credit substitution.