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Interest Rate Caps in an Economy with Formal and Informal Credit Markets

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  • Pozo, Jorge

    (Banco Central de Reserva del Perú)

Abstract

In this work, we aim to study the implications of the interest rate cap in an emerging economy. To do so we develop a two-period banking model with entrepreneurs that undertake risky projects and with formal and informal lenders. Entrepreneurs are heterogeneous in their level of net worth. We find that a cap on the lending interest rate excludes entrepreneurs with a low level of net worth, which in turn increases the participation of the informal credit market, but also might reduce bank markups increasing entrepreneurs' welfare. Our findings imply that the lower the market power of banks, the smaller the likelihood that the cap might have some positive impact on aggregate credit and investment. Furthermore, we suggest that the lower the financial inclusion and the higher the asymmetric information problem, the higher the likelihood of caps harming the economy, due to caps preventing clients to create a good credit history and improve their credit conditions.

Suggested Citation

  • Pozo, Jorge, 2023. "Interest Rate Caps in an Economy with Formal and Informal Credit Markets," Working Papers 2023-002, Banco Central de Reserva del Perú.
  • Handle: RePEc:rbp:wpaper:2023-002
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    References listed on IDEAS

    as
    1. Madestam, Andreas, 2014. "Informal finance: A theory of moneylenders," Journal of Development Economics, Elsevier, vol. 107(C), pages 157-174.
    2. Safavian,Mehnaz S. & Zia,Bilal Husnain, 2018. "The impact of interest rate caps on the financial sector : evidence from commercial banks in Kenya," Policy Research Working Paper Series 8393, The World Bank.
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    9. Pozo, Jorge, 2020. "Efectos no deseados de los topes a las tasas de interés: Una revisión empírica y teórica," Revista Moneda, Banco Central de Reserva del Perú, issue 183, pages 8-13.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Topes a la tasa de interés; crédito informal; monopolio;
    All these keywords.

    JEL classification:

    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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