Banking Productivity and Economic Fluctuations: Colombia 1998-2000

Abstract

This paper builds a general equilibrium, financial accelerator model
that incorporates an explicit technology for the intermediary sector. A
credit multiplier emerges because of a borrowing constraint that is a
function of asset prices, internal funds and lending rates. With this
financial friction I show that small changes in the productivity and
intermediation costs of banks generate large and persistent fluctuations
in economic activity. The transmission channel relies on the role
that assets and internal funds play as collateral. After a negative shock
hits financial intermediation productivity, the resulting credit crunch
and economic slowdown induce a fall in asset prices and internal fund
accumulation. This further modifies the present and future volume of
collateral, thereby amplifying and propagating the initial shock. The
paper argues that changes in banking regulation in Colombia in the
late 1990?s increased intermediation costs, reduced banking productivity
and induced a credit multiplier story that fits the theoretical
model presented here. This new regulation enhanced the credit crunch
and economic slowdown that was already underway. Colombian data
on loan/deposit interest rate spreads, credit volume, asset prices and
economic activity support this argument.