Speaker: Xavier Freixas is a Professor of Economics at Universitat Pompeu Fabra in Barcelona, Spain. More »
Abstract: This paper analyses the role of a Public Development Bank when banks use a costly screening technology to make credit decisions. We explore three issues: 1) what is the main financial market imperfection to be addressed by the PDB; 2) which types of firms should be optimally targeted by public financial support; and 3) what type of mechanism should be implemented in order to efficiently support the targeted firms’ access to credit. We show that, in the presence of costly screening, there will be underprovision of credit, resulting from the inability of banks to appropriate the full benefits of projects they finance. 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 financing of high value projects, contrast with the usual emphasis on credit underprovision for relatively weak projects/firms (SMEs, young firms, those without collateral, etc.). We show that a public development bank may alleviate these inefficiencies by lending to commercial banks at subsidized rates or providing credit guarantees, targeting the firms that generate high added value. Though in "normal times" PDB lending and credit guarantees are shown to be equivalent, lending is preferred when banks are facing a liquidity shortage, while when banks are undercapitalized, a credit guarantees program is best suited to alleviate the constraints banks’ face. Direct lending by the PDB to the targeted industries could be superior to these subsidies to private lending, but only if the PDBs corporate governance is strong enough to counteract the temptation of political targeting, an assumption that seems to contradict available empirical evidence.
Last Updated: Sep 26, 2016