Essays is bank competition and credit policy

Abstract

This thesis estimates the eect of competition in the financial sector using both individual level data and economic theory, and explores the role of credit policy in mitigating potential adverse effects of imperfect competition. The first essay uses heterogeneous exposure to large bank mergers to estimate the eect of bank competition on both financial and real variables in local Brazilian markets. Using detailed administrative data on loans and firms, we employ a difference-in-differences empirical strategy to identify the causal eect of bank competition. Following M&A episodes, spreads increase and there is persistently less lending in exposed markets. We also find that bank competition reduces employment. We develop a tractable model of heterogeneous firms and concentration in the banking sector and show that the observed effects in the data and predicted by the model are consistent.

Among other counterfactuals, we show that if the Brazilian lending spread were to fall to the world level, output would increase by approximately 5%. The second essay develops a contract-based model of industrial organization for markets characterized by information and other frictions (Moral Hazard, Limited Commitment, Adverse Selection etc.) and dierent market structures (Monopoly, Oligopoly, Competition), the latter driven by spatial costs, idiosyncratic preferences, and number of financial service providers. We derive a likelihood estimator for the structural parameters that determine contracting frictions and market structure and apply this to the Townsend Thai data on small and medium enterprises and bank locations. Our model of production is microfounded and thus can be used for a broad set counterfactuals. The third essay explores the role of credit policies to mitigate the effects of lack of competition in the financial sector.

In many emerging markets, governments try to increase credit access and stimulate economic growth by imposing caps on lending rates. We analyze these policies by extending workhorse models with financial frictions to include a banking sector with market power. Caps are beneficial as they reduce credit costs but are also harmful as they crowd out risky borrowers which can access credit only at high interest rates, and thus have an ambiguous effect in current output and capital accumulation. We show that the optimal policy to maximize steady state welfare involves relatively high caps on a large share of bank loans. The optimal policy decreases output today, but increases capital accumulation through a lower cost of credit and thus output in the future. Thanks to tractable aggregation properties, the framework can be used to analyze a broad set of alternative credit policies.