Does alternative finance moderate bank fragility? Evidence from the euro area

Over recent years stricter EU capital requirements have resulted in constraining bank lending to SMEs. Alternative finance is expected to ease such constraints, but what would it be its impact on bank fragility? This paper examines whether alternative finance for Small and Medium Enterprises (SMEs) in the euro area would moderate bank fragility. We employ a bank profit model from which we derive a novel measure of bank fragility that is based on micro-foundations and is estimated in a single stage with Bayesian techniques. Controlling for many bank and firm specific variables, including bank capital adequacy ratios and volatility, we find that alternative finance overall strengthens bank stability, but that there is some variability in this impact over time and across countries. Interestingly, while higher bank capital adequacy ratios at times may even increase fragility, their interactions with alternative finance could help reduce it.