Heterogeneous Banking Efficiency: Allocative Distortions and Lending Fluctuations
66 Pages Posted: 3 Jan 2014
Date Written: January 2014
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