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Public Development Banks and Credit Market Imperfections

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  • Marcela Eslava
  • Xavier Freixas

Abstract

This paper analyses the role of a public development bank when banks use a costly screening technology to make credit decisions. We explore two issues: 1) which types of firms should be optimally targeted by public financial support; and 2) what type of mechanism should be implemented in order to efficiently support the targeted firms’ access to credit. We show that, in the presence of costly screening, the market leads to an inefficient allocation, as there will be underprovision of credit. The market imperfection results from the inability of banks to appropriate the full benefits of projects they finance. This implies that the misallocation of credit is more pronounced for high value projects. This central result, and its implication that PDBs could play a central role in the financing of high value projects, contrast with the usual emphasis on credit underprovision for relatively weak projects/firms (SMEs, young firms, those without collateral, etc.). We show that a public development bank may alleviate the inefficiencies by lending to commercial banks at subsidized rates and targeting the firms that generate high added value. This may be implemented through subsidized ear-marked lending to the banks or through credit guarantees which, in "normal times", we show to be equivalent. Still, when banks are facing a liquidity shortage, lending is preferred, while when banks are undercapitalized, a credit guarantees program is best suited to alleviate the constraints banks’ face.

Suggested Citation

  • Marcela Eslava & Xavier Freixas, 2016. "Public Development Banks and Credit Market Imperfections," Working Papers 874, Barcelona Graduate School of Economics.
  • Handle: RePEc:bge:wpaper:874
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    References listed on IDEAS

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    Cited by:

    1. Jean Bonnet & Sylvie Cieply & Marcus Dejardin, 2016. "Credit rationing or overlending? An exploration into financing imperfection," Applied Economics, Taylor & Francis Journals, vol. 48(57), pages 5563-5580, December.
    2. Marcela Eslava & John C. Haltiwanger & Alvaro Pinzón, 2019. "Job creation in Colombia vs the U.S.: “up or out dynamics” meets “the life cycle of plants”," NBER Working Papers 25550, National Bureau of Economic Research, Inc.
    3. José Antonio Ocampo & Paola Arias & Juan David Torres, 2018. "La banca nacional de desarrollo en Colombia," Revista ESPE - Ensayos sobre Política Económica, Banco de la Republica de Colombia, issue 88, pages 1-36, December.
    4. Frigerio, Marco & Vandone, Daniela, 2020. "European development banks and the political cycle," European Journal of Political Economy, Elsevier, vol. 62(C).
    5. Chatzouz, Moustafa & Gereben, Áron & Lang, Frank & Torfs, Wouter, 2017. "Credit guarantee schemes for SME lending in Western Europe," EIB Working Papers 2017/02, European Investment Bank (EIB).
    6. Gabriel Jiménez & José-Luis Peydró & Rafael Repullo & Jesús Saurina, 2017. "Burning Money? Government Lending in a Credit Crunch," Working Papers 984, Barcelona Graduate School of Economics.
    7. Marco FRIGERIO & Daniela VANDONE, 2018. "Virtuous or Vicious? Development Banks in Europe," Departmental Working Papers 2018-07, Department of Economics, Management and Quantitative Methods at Università degli Studi di Milano.

    More about this item

    Keywords

    public development banks; governmental loans and guarantees; costly screening; credit rationing;

    JEL classification:

    • H81 - Public Economics - - Miscellaneous Issues - - - Governmental Loans; Loan Guarantees; Credits; Grants; Bailouts
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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