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Financial Liberalization and Intervention

A New Analysis of Credit Rationing

Santonu Basu

This book seeks to provide a coherent explanation as to why the policies of financial liberalization and financial intervention have been unable to achieve the goal of improving the access of borrowers to the loan market, irrespective of size. This is one of the prime criteria for achieving efficiency in the operation of the loan market and its failure has resulted in increased uncertainty and financial fragility.
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Chapter 4: Financial Liberalization

A New Analysis of Credit Rationing

Santonu Basu


1 4.1 INTRODUCTION McKinnon (1973) and Shaw (1973) provide a theoretical explanation as to why a mandatory ceiling on interest rates, and numerous lending restrictions that have been imposed on the banks, may have caused variations in access to the loan market for different groups of borrowers. In Chapter 2 we argued that this explanation is not adequate. However their argument is not confined to the issue of credit rationing, but extends to an explanation of how these regulations in turn may adversely affect the growth rate. They argue that a ceiling on interest rates which is below that of the market clearing rate, depresses savings, thereby reducing the availability of funds for investment growth, and encourages investors to undertake low yield investments, resulting in a low growth rate. Thus the essential argument is that financial repression causes low growth rate. Accordingly, they recommend financial liberalization, often referred to as deregulation, which involves lifting the ceiling on interest rates, the removal of various lending restrictions that were previously imposed on banks and the removal of barriers to entry, and suggest that this course of action will produce a higher growth rate. While McKinnon and Shaw mainly focus on exogenous factors (e.g. the impact of government intervention on financial markets), the recent literature following this line of thought focuses on the endogenous process, that is, in the absence of intervention how the endogenous process will produce a higher growth rate. This in turn gives further credence to McKinnon’s and Shaw’s thesis....

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