In the context of the European crisis, we show that the security portfolio of banks
plays an important role in the propagation of financial shocks across countries. Using
Italian loan-level data, we show that the shock to the banks’ sovereign portfolio caused
by the 2010 Greek bailout was passed on to Italian firms through a credit contraction.
This was particularly the case for banks with a lower capital and less stable funding. The contraction in credit was similar for both large and small firms, but it only negatively affected the investment and employment decisions of small firms.