Abstract
The paper demonstrates that monopoly banking can explain both the prevalence of moneylenders and the high effective interest rates in many developing credit markets. When moneylenders are rich relative to entrepreneurs, a monopoly bank can extract more rent by channeling funds through moneylenders than by lending directly to entrepreneurs. The argument rests on the assumption that moneylenders are better than banks at preventing opportunistic behavior of entrepreneurs. When moneylenders are sufficiently rich relative to entrepreneurs, they are less prone to divert bank funds. Therefore, a monopoly bank need not share rents when it lends through the moneylender. Banking competition is the key to both eliminating usurious interest rates charged by moneylenders and promoting investment.