Public Development Banks and Credit Market Imperfections
Social Science Research Network
This paper analyses the role of a public development bank when banks use a costly screening technology to make credit decisions. We explore two issues: 1) which types of ...rms should be optimally targeted by public ...nancial support; and 2) what type of mechanism should be implemented in order to e¢ ciently support the targeted ...rms' access to credit. We show that, in the presence of costly screening, the market leads to an in-e¢ cient allocation, as there will be underprovision of credit.
... ovision of credit. The market imperfection results from the inability of banks to appropriate the full bene...ts of projects they ...nance. This implies that the misallocation of credit is more pronounced for high value projects. This central result, and its implication that PDBs could play a central role in the ...nancing of high value projects, contrast with the usual emphasis on credit underprovision for relatively weak projects/...rms (SMEs, young ...rms, those without collateral, etc.). . We show that a public development bank may alleviate the ine¢ ciencies by lending to commercial banks at subsidized rates and targeting the ...rms that generate high added value. This may be implemented through subsidized ear-marked lending to the banks or through credit guarantees which, in "normal times", we show to be equivalent . Still, when banks are facing a liquidity shortage, lending is preferred, while when banks are undercapitalized, a credit guarantees program is best suited to alleviate the constraints banks'face.