Development banking

This paper develops a model of a (laissez-faire) decentralized banking syst em in which banks are shown to both underinvest in, and undertransmit exper tise in long-term industrial finance. Government support for one financial institution ('the development bank') can serve to reduce these problems, bu t unqualified government support alone is not enough. The efficiency of gov ernment sponsorship can be enhanced if certain conditions are attached to t hat sponsorship. Crucially, these include targeting of development bank int ervention, co-financing arrangements and/or co-ownership with private finan cial institutions. The relevance of the analysis for LDCs is discussed by c ontrasting the successful historical development banking experience of Fran ce with the more recent unsuccessful experience of Mexico. (C) 1999 Elsevie r Science B.V, All rights reserved.