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Title: Public Development Banks and Credit Market Imperfections

Author(s): Marcela Eslava and Xavier Freixas

Publication Date: March 2016

Keyword(s): Costly screening, Credit rationing, Governmental loans and guarantees and Public development banks

Programme Area(s): Development Economics and Financial Economics

Abstract: This paper is devoted to understanding the role of public development banks in alleviating financial market imperfections. We explore two issues: 1) which types of firms should be optimally targeted by public financial support; and 2) what type of mechanism should be implemented in order to efficiently support the targeted firms' access to credit. We model firms that face moral hazard and banks that have a costly screening technology, which results in a limited access to credit for some firms. We show that a public development bank may alleviate the inefficiencies by lending to commercial banks at subsidized rates, targeting the firms that generate high added value. This may be implemented through subsidized ear-marked lending to the banks or through credit guarantees which we show to be equivalent in "normal times". Still, when banks are facing a liquidity shortage, lending is preferred, while when banks are undercapitalized, a credit guarantees program is best suited. This will imply that 1) there is no "one size fits all" intervention program and 2) that any intervention program should be fine-tuned to accommodate the characteristics of competition, collateral, liquidity and banks capitalization of each industry.

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Bibliographic Reference

Eslava, M and Freixas, X. 2016. 'Public Development Banks and Credit Market Imperfections'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=11160