Credit Quantity and Credit Quality: Bank Competition and Capital Accumulation

39 Pages Posted: 15 Jun 2009

See all articles by Nicola Cetorelli

Nicola Cetorelli

Federal Reserve Bank of New York

Pietro F. Peretto

Duke University - Department of Economics; Duke Innovation & Entrepreneurship Initiative

Multiple version iconThere are 2 versions of this paper

Date Written: June 1, 2009

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.

Keywords: bank competition, economic growth, oligopoly, lending

JEL Classification: G1, G2, L1, L2, O1, O4

Suggested Citation

Cetorelli, Nicola and Peretto, Pietro F., Credit Quantity and Credit Quality: Bank Competition and Capital Accumulation (June 1, 2009). FRB of New York Staff Report No. 375, Available at SSRN: https://ssrn.com/abstract=1418030 or http://dx.doi.org/10.2139/ssrn.1418030

Nicola Cetorelli (Contact Author)

Federal Reserve Bank of New York ( email )

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Pietro F. Peretto

Duke University - Department of Economics ( email )

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Duke Innovation & Entrepreneurship Initiative ( email )

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