DP12443 Schumpeterian Banks: Credit Reallocation and Capital Structure

Author(s): Christian Keuschnigg, Michael Kogler
Publication Date: November 2017
Keyword(s): Banking, credit reallocation, finance and growth, regulations
JEL(s): D92, G21, G28, G33
Programme Areas: Public Economics, Financial Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=12443

Capital reallocation from unprofitable to profitable firms is a key source of productivity gain in an innovative economy. We present a model of credit reallocation and focus on the role of banks: Weakly capitalized banks hesitate to write off non-performing loans to avoid a violation of regulatory requirements or even insolvency. Such behavior blocks credit reallocation to expanding industries and results in a distorted investment process and low aggregate productivity. Reducing the cost of bank equity, tightening capital requirements, and improving insolvency laws relaxes constraints and mitigates distortions.