Credit Availability and Capital Crunch: On the Role of the Heterogeneity of the Banking System

We analyze the impact of a credit crunch on aggregate investment via the heterogeneous structure of the banking system. We develop a model of endogenous credit allocation in which investors and two banks differ according to their level of capital and monitoring technology. In a context of moral haza...

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Bibliographic Details
Published in:Journal of public economic theory 2009-04, Vol.11 (2), p.251-279
Main Author: BRUNO, OLIVIER
Format: Article
Language:English
Subjects:
Banking industry
Banks
Capital
Credit
Economic models
Economic statistics
Economic theory
Economics and Finance
Humanities and Social Sciences
Investments
Moral hazard
Small business
Studies
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Summary:We analyze the impact of a credit crunch on aggregate investment via the heterogeneous structure of the banking system. We develop a model of endogenous credit allocation in which investors and two banks differ according to their level of capital and monitoring technology. In a context of moral hazard problem, we show that banks' cost advantage in the monitoring of small businesses must be compared to their relative amount of capital in order to explain firms' optimal choice of financing, the credit allocation in the economy and the asymmetric impact of a credit crunch on aggregate investment. A shock of the same magnitude on the two banks level of capital may have a different effect on total investment. We stress that the credit crunch is maximum when the shock hits the bank specialized in the financing of small businesses and when this bank is also the less capitalized. This result is supported by recent empirical studies (Hancock and Wilcox 1998).
ISSN:1097-3923
1467-9779
DOI:10.1111/j.1467-9779.2009.01409.x