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Credit quantity and credit quality: bank competition and capital accumulation

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Author Info
Nicola Cetorelli
Pietro F. Peretto

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Abstract

This paper shows that bank competition has an intrinsically ambiguous effect on capital accumulation and economic growth. We further demonstrate that banking market structure can be responsible for the emergence of development traps in economies that would otherwise be characterized by unique steady-state equilibria. These predictions explain the conflicting evidence gathered from recent empirical studies of how bank competition affects the real economy. Our results were obtained by developing a dynamic general-equilibrium model of capital accumulation in which banks operate in a Cournot oligopoly. The presence of more banks leads to a higher quantity of credit available to entrepreneurs, but also to diminished incentives to screen loan applicants and thus to poorer capital allocation. We also show that conditioning on economic parameters describing the quality of the entrepreneurial population resolves the theoretical ambiguity. In economies where the average prospective entrepreneur is of low credit quality and where screening would therefore be especially beneficial, less competition leads to higher capital accumulation. The opposite is true when entrepreneurs are innately of higher credit quality.

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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 375.

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Date of creation: 2009
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Handle: RePEc:fip:fednsr:375

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Related research
Keywords: Bank competition ; Banking structure;

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  2. Petersen, Mitchell A & Rajan, Raghuram G, 1995. "The Effect of Credit Market Competition on Lending Relationships," The Quarterly Journal of Economics, MIT Press, vol. 110(2), pages 407-43, May. [Downloadable!] (restricted)
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  3. Sharpe, Steven A, 1990. " Asymmetric Information, Bank Lending, and Implicit Contracts: A Stylized Model of Customer Relationships," Journal of Finance, American Finance Association, vol. 45(4), pages 1069-87, September. [Downloadable!] (restricted)
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  4. Sandra E. Black & Philip E. Strahan, 2002. "Entrepreneurship and Bank Credit Availability," Journal of Finance, American Finance Association, vol. 57(6), pages 2807-2833, December. [Downloadable!] (restricted)
  5. Leland, Hayne E & Pyle, David H, 1977. "Informational Asymmetries, Financial Structure, and Financial Intermediation," Journal of Finance, American Finance Association, vol. 32(2), pages 371-87, May. [Downloadable!] (restricted)
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  6. Thakor, Anjan V, 1996. " Capital Requirements, Monetary Policy, and Aggregate Bank Lending: Theory and Empirical Evidence," Journal of Finance, American Finance Association, vol. 51(1), pages 279-324, March. [Downloadable!] (restricted)
  7. Bertrand, Marianne & Schoar, Antoinette S & Thesmar, David, 2004. "Banking Deregulation and Industry Structure: Evidence from the French Banking Reforms of 1985," CEPR Discussion Papers 4488, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  9. Bonaccorsi di Patti, Emilia & Dell'Ariccia, Giovanni, 2004. "Bank Competition and Firm Creation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(2), pages 225-51, April.
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  10. Zarutskie, Rebecca, 2006. "Evidence on the effects of bank competition on firm borrowing and investment," Journal of Financial Economics, Elsevier, vol. 81(3), pages 503-537, September. [Downloadable!] (restricted)
  11. Nicola Cetorelli, 2001. "Banking Market Structure, Financial Dependence and Growth: International Evidence from Industry Data," Journal of Finance, American Finance Association, vol. 56(2), pages 617-648, 04. [Downloadable!] (restricted)
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  12. Nicola Cetorelli & Philip E. Strahan, 2006. "Finance as a Barrier to Entry: Bank Competition and Industry Structure in Local U.S. Markets," Journal of Finance, American Finance Association, vol. 61(1), pages 437-461, 02. [Downloadable!] (restricted)
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  13. Bhattacharya Sudipto & Thakor Anjan V., 1993. "Contemporary Banking Theory," Journal of Financial Intermediation, Elsevier, vol. 3(1), pages 2-50, October. [Downloadable!] (restricted)
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  15. Franklin Allen & Douglas Gale, 2004. "Financial Intermediaries and Markets," Econometrica, Econometric Society, vol. 72(4), pages 1023-1061, 07. [Downloadable!] (restricted)
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  16. Campbell, Tim S & Kracaw, William A, 1980. " Information Production, Market Signalling, and the Theory of Financial Intermediation," Journal of Finance, American Finance Association, vol. 35(4), pages 863-82, September. [Downloadable!] (restricted)
  17. Shaffer, Sherrill, 1998. "The Winner's Curse in Banking," Journal of Financial Intermediation, Elsevier, vol. 7(4), pages 359-392, October. [Downloadable!] (restricted)
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  18. Dell'Ariccia, Giovanni & Marquez, Robert, 2004. "Information and bank credit allocation," Journal of Financial Economics, Elsevier, vol. 72(1), pages 185-214, April. [Downloadable!] (restricted)
  19. Robert Hauswald & Robert Marquez, 2006. "Competition and Strategic Information Acquisition in Credit Markets," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 19(3), pages 967-1000. [Downloadable!] (restricted)
  20. Levine, Ross, 2005. "Finance and Growth: Theory and Evidence," Handbook of Economic Growth, in: Philippe Aghion & Steven Durlauf (ed.), Handbook of Economic Growth, edition 1, volume 1, chapter 12, pages 865-934 Elsevier. [Downloadable!] (restricted)
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  21. Robert Marquez, 2002. "Competition, Adverse Selection, and Information Dispersion in the Banking Industry," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 15(3), pages 901-926.
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