Costly Monitoring, Financial Intermediation, and Equilibrium Credit Rationing

This paper establishes a link between equilibrium credit rationing and financial intermediation, in a model with asymmetrically informed lenders and borrowers, costly monitoring with increasing returns to scale, and investment project indivisibilities. Intermediation dominates borrowing and lending between individuals. Equilibrium interest rates, the aggregate quantity of loans, and the size of each intermediary firm respond different to changes in taste and technology parameters, depending on whether or not there is rationing in equilibrium.