Banking Productivity and Economic Fluctuations: Colombia 1998-2000

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