Oligopoly Banking and Capital Accumulation∗

We develop a dynamic general equilibrium model of capital accumulation where credit is intermediated by banks operating in a Cournot oligopoly. The number of banks affects capital accumulation through two channels. First, it affects the quantity of credit available to entrepreneurs. Second, it affects banks’ decisions to collect costly information about entrepreneurs, and thus determines the efficiency of the credit market. We show that under plausible conditions, the market structure that maximizes the economy’s steady-state income per capita is neither a monopoly nor competition, but an intermediate oligopoly. Moreover, the credit market splits in two segments: one in which loans are screened and only high quality entrepreneurs obtain credit, and one in which banks extend credit indiscriminately to all entrepreneurs. The relative size of the two segments depends on the market power of banks and evolves endogenously along the path of capital accumulation. We thus obtain the prediction that the banking sector becomes more sophisticated as the economy develops. JEL code: G1, G2, L1, L2, O1, O4 ∗We benefited from the comments of seminar participants at the Federal Reserve Bank of Chicago and Duke University. We also thank Enrique Mendoza and Ruilin Zhou for fruitful conversations, and in particular Ed Green for his many insightful remarks. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Chicago or the Federal Reserve System. †Corresponding author. Mailing address: Federal Reserve Bank of Chicago, 11th Floor, 230 South La Salle St., Chicago, IL 60604, USA. E-mail: [email protected]