Banking with credit rationing and default risk with an application to developing countries (Argentina)

Financial intermediation plays an important role in the capital allocation process, especially in developing economies. Credit rationing and aggregate risk which cannot be eliminated by diversification are important phenomenon. These can affect the fundamental viability of a financial intermediary. Credit rationing and bank failures disrupt the capital accumulation process and reduce growth. I present a model of a “risky bank”. The bank is subject to nondiversifiable aggregate risk. As a consequence, the bank may sometimes default on depositors. Banks can manage their inability to repay depositors in some states of nature by rationing credit to risky borrowers. Credit rationing can takes two forms, quantity and quality rationing. The model adds to the literature of equilibrium credit rationing in costly state verification environments, which focuses on the extent of quantity rationing under optimal debt contracts. The second chapter studies the effect of credit rationing on the level of production in a similar framework. We show that economies with more efficient banking systems lend to riskier borrowers. The gains from this reduce the credit rationing problem and generate an increase in the per capita capital level. The third chapter is an empirical application that examines the role of risk in the restructuring of the Argentine banking system during the period 1995–1999.; The thesis shows the importance of default risk on the behavior of banking institutions. Indeed, default risk, regulation and institutional factors affect spreads. They also have an important effect on credit rationing. This effect on credit rationing is not only on loan quantity but also on portfolio quality. Institutions improve portfolio quality, but also increase credit rationing affecting capital accumulation.