Financial Intermediation and Income Distribution

Abstract

What is the social impact of the financial intermediation sector? I analyze the aggregate and the redistribution impact of financial intermediaries in an economy with a set of potential entrepreneurs. The intermediation sector endogenously develops to relax credit constraints by monitoring a borrowing entrepreneur. Competitive intermediaries i) eradicate non-fundamental-based income inequality by spreading economic opportunity to financially constrained individuals—the redistribution impact, and ii) boost entrepreneurship and restore the socially optimal occupational pattern—the job-creation impact. Although the job-creation impact is socially beneficial, the redistribution impact is not—social surplus declines overall due to a pecuniary externality associated with the redistribution function of the financial intermediation sector. Monopoly intermediation limits the redistribution impact and may raise the utilitarian welfare.

Keywords: Financial Intermediation, Income Inequality, Financing Friction, Entrepreneurship, Moral Hazard, Pledgeability, Externalities.