Heterogeneous Banking Efficiency: Allocative Distortions and Lending Fluctuations

66 Pages Posted: 3 Jan 2014

Multiple version iconThere are 2 versions of this paper

Date Written: January 2014

Abstract

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

Duprey, Thibaut, Heterogeneous Banking Efficiency: Allocative Distortions and Lending Fluctuations (January 2014). Banque de France Working Paper No. 464, Available at SSRN: https://ssrn.com/abstract=2373945 or http://dx.doi.org/10.2139/ssrn.2373945

Thibaut Duprey (Contact Author)

Bank of Canada ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

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