Heterogeneous Banking Efficiency: Allocative Distortions and Lending Fluctuations
66 Pages Posted: 27 Nov 2013
Date Written: November 22, 2013
This paper is a first attempt to connect the heterogeneity in bank efficiency with lending fluctuations and allocation efficiency : there is a trade-off between the two in the presence of heterogeneity in bank monitoring efficiency. The mechanism at hand is twofold. (a) First the rent extracted by the most efficient bank distorts incentives of entrepreneurs to undertake efforts. (b) Second banks specialising on contracts that do not include monitoring feature less cyclical fluctuations of aggregate lending. This has clear implications: (i) the presence of banking heterogeneity decreases firms’ average productivity as it increases adverse selection by entrepreneurs as well as favours rent extractions by banks; (ii) an individual bank featuring a lower cyclicality signals a lower efficiency in its monitoring abilities; (iii) a heterogeneous banking system featuring a lower cyclicality of aggregate lending might not be desirable as it may come along with allocative and incentives distortions.
Keywords: banking heterogeneity, moral hazard, adverse selection, endogenous market segmentation, allocation efficiency, lending cycle
JEL Classification: G21, E30
Suggested Citation: Suggested Citation