Lending Rate Caps and Credit Reallocation

We estimate the effects of lending rate caps by studying a regulation that prohibited interest rates above 83.4% in Peru, affecting 27% of loans to small firms. We find that this policy generated substantial credit reallocation with implications for financial stability. At the loan-level, banks reduce small-size loans and expand medium-size credit, favoring incumbent firms at the expense of new borrowers. At the city level, we define treatment as the percent decline in interest payments necessary to bring interest rates down to the lending rate cap in the pre-reform period. Using a difference-in-differences approach, we estimate that one standard deviation higher treatment leads to a 5 percentage points decline in interest rates with null effects on credit because banks reallocate loans away from risky borrowers towards safer clients in highly concentrated bank credit markets. The decline in interest payments and the reallocation of credit cause a reduction in the share of non-performing loans, suggesting a minor role for risk-taking incentives associated with the deterioration of banks charter value when interest rates are regulated.