The Objective Function of Government-Controlled Banks in a Financial Crisis

Abstract

We present evidence that government-controlled banks (GCBs) significantly increased their lending to small and medium-sized enterprises (SMEs) whose main bank was a large bank in the 2007–09 financial crisis. Further analyses show that both the weak relationship between large banks and SMEs and the crowding out due to the loan demand surge among large corporations facing the securities market paralysis contributed to this phenomenon. The mixed Cournot oligopoly model, including a GCB, shows that the above finding regarding the weak relationship is consistent with the welfare maximization by a GCB rather than its own profit maximization.

Keywords: Government-Controlled Banks, Mixed Oligopoly, Relationship Banking, Small Business Financing

JEL Classification: G21, H44