This paper analyzes how banks’ funding constraints impact the access and cost of capital of
small firms. Banks raise external finance from a large number of small investors who face coordination
problems and invest in small, risky businesses. When investors observe noisy signals
about the true implementation cost of real sector projects, the model can be solved for a threshold
equilibrium in the classical global games approach. We show that a “socially optimal” interest
rate that maximizes the probability of success of the small firm is higher than the risk-free rate,
because higher interest rates relax the bank’s funding constraint. However, banks will generally
set an interest rate higher than this socially optimal one. This gives rise to a built-in inefficiency of
banking intermediation activity that can be corrected by various policy measures.
PEIA, O. et VRANCEANU, R. (2015). Bank Funding Constraints and the Cost of Capital of Small Firms. ESSEC Business School.