Facing the need to “repair” their balance sheet following an adverse shock, ﬁrms reduce investment with negative effects for economic growth. In both cases, the ﬁnancial sector may act as an ampliﬁer. In light of a debt overhang of ﬁrms and households, banks’ may face a surge in nonperforming loans.
In a benign scenario, this may cause a reduction in credit availability, additionally dragging on the macroeconomy. In the most extreme case, a surge in nonperforming loans may even threaten the solvency of banks. Banks foregoing proﬁtable lending activities may aggravate the initial shock (Philippon and Schnabl 2013).