Wealth creation is closely related to the ability of individuals and
households to transform their talent and other inputs into marketable goods and
services. The credit market permits the allocation of resources among financial
intermediaries such as banks, and talented entrepreneurs, enabling these
individuals to start their own businesses and expand their production
capacities. This dimension of wealth creation and entrepreneurial dynamism can
be uniquely observed in the elements behind a credit contracts, or lending
agreements between a bank and an individual. In order to examine the incentives
of both banks and entrepreneurs behind these contracts, we take advantage of a
unique series of databases that combine quarterly information of banks, firms,
and credit contracts for Mexican commercial banking from 2004 to 2007.
The credit contracts we observe differ in terms of interest rates and
loan amounts according to the characteristics of both banks and entrepreneurs. For
example, firms are characterized by their scale of production, productivity,
geographic location, economic sector, and number of workers. On the other hand,
intermediaries such as commercial banks, have different managerial capacities
and market deepening, traduced in differences among their capitalization costs.
Given these characteristics, both groups seek the best loan terms for
themselves. Consideration is also given to other factors, such as competitors in
the market and conditions of other relevant markets. Therefore, groups on both
sides of the market have incentives to "match" with each other and agree to a
mutually beneficial contract. As such, banks have developed technology to
better seek out talented entrepreneurs*.
However, banks may not always make loans to the best customers and the best
customers may not always attain the best credit because this optimal matching
process can be distorted by the presence of barriers to entry in the industry,
fixed costs, asymmetric information, and default incentives, among others.
Using a matching framework adapted to the particularities of
bank-client relationships, preliminary analysis finds that talented
entrepreneurs are typically offered credit contracts with better terms, such as
lower interest rates or higher loan amounts. While this increases investment in
an individual's business, it also benefits other entrepreneurs, in that banks
seek out talented entrepreneurs, enter into successful credit contracts, and
use the profits to extend loans to additional, albeit less talented, individuals.
This expansion of credit is fueled further by an increase of banks in Mexico
over the time period studied, resulting in outreach of banking credit toward more
firms and with lower capital requirements. This acts as trickle-down effect, in
that the credit market allocates capital to entrepreneurs via unique credit
contracts and facilitates the expansion of the market to additional
entrepreneurs.
The process of wealth creation is complex, as we find in this examination
of credit contracts and matching. Ultimately, the most talented entrepreneurs
are rewarded with better loan terms. Others, too, benefit from this process, as
credit is extended to more individuals. The credit market's role in
entrepreneurial success should not be understated, as it enables - or prevents
- individuals from starting businesses, purchasing necessary assets, and
expanding production.
Post submitted by Jorge O. Moreno, Ph.D. Candidate at the University of Chicago
*Entrepreneurial talent is defined by productivity.
Photo by malias.
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