Staff Reports
Credit Quantity and Credit Quality: Bank Competition and Capital Accumulation
June 2009 Number 375
JEL classification: G1, G2, L1, L2, O1, O4

Authors: Nicola Cetorelli and Pietro F. Peretto

This paper shows that bank competition has an intrinsically ambiguous effect on capital accumulation and economic growth. We further demonstrate that banking market structure can be responsible for the emergence of development traps in economies that would otherwise be characterized by unique steady-state equilibria. These predictions explain the conflicting evidence gathered from recent empirical studies of how bank competition affects the real economy. Our results were obtained by developing a dynamic general-equilibrium model of capital accumulation in which banks operate in a Cournot oligopoly. The presence of more banks leads to a higher quantity of credit available to entrepreneurs, but also to diminished incentives to screen loan applicants and thus to poorer capital allocation. We also show that conditioning on economic parameters describing the quality of the entrepreneurial population resolves the theoretical ambiguity. In economies where the average prospective entrepreneur is of low credit quality and where screening would therefore be especially beneficial, less competition leads to higher capital accumulation. The opposite is true when entrepreneurs are innately of higher credit quality.
Available only in PDF pdf 39 pages / 380 kb
For a published version of this report, see Nicola Cetorelli and Pietro F. Peretto, "Credit Quantity and Credit Quality: Bank Competition and Capital Accumulation," Journal of Economic Theory 147, no. 3 (May 2012): 967-98.
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