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This paper identifies a credit-supply contraction that arises endogenously after
trade liberalization. Banks with loan portfolios concentrated in sectors exposed to
competition from China face an increase in non-performing loans after China’s entry
into the World Trade Organization. As a result, they reduce the supply of credit to
firms, irrespective of the firm’s sector of operation. This cut in credit translates into
lower employment, investment, and output. Through this mechanism, the financial
channel amplifies the shock to firms already hit by import competition from China
and passes it on to firms in sectors expected to expand upon trade liberalization.
