Forty years of regional development policies have induced massive
capital inflows and real income transfers into Italy's Mezzogiorno but
have not closed its income gap with the North. In Discussion Paper No.
674, Research Fellow Riccardo Faini, Giampaolo Galli and Curzio
Giannini examine the contribution of inefficient financial
intermediation to this lack of convergence. Southern financial
institutions have higher operating costs, default rates and interest
rates, but differences between borrowing firms in the two regions
account for only half the average interest rate differential. Southern
banks charge Southern firms higher interest rates than Northern banks
(even controlling for risk), which reflect their higher operating costs
and suggest that they are sheltered from external competition.
Faini, Galli and Giannini attribute Southern firms' failure to take
advantage of Northern banks' lower interest rates to informational
problems. Southern banks can gather the information needed to identify
individual borrowers' risk levels, while external banks must resort to
rationing. To support this view, they note first that Southern banks
charge even higher interest rates to `local' firms those in their own
province but there is no such effect in the North. Second, for a sub-
sample of firms in Sicily that borrow from local and external banks,
local banks charge more but provide most of their finance. Third,
Southern firms make greater use of existing credit lines with Northern
banks, which suggests that the latter resort to rationing.
Faini, Galli and Giannini then use the estimates from their interest
rate equations to show that Southern firms are no more difficult to
screen then others, but Southern banks screen less efficiently. Risk
exerts a larger effect on Southern firms' borrowing, which may be
because the regulatory framework discourages borrowing on
longer-maturity and riskier projects. High-risk firms in the South often
face liquidity constraints in investment decisions, with a lack of
external finance preventing them from undertaking profitable projects.
Faini, Galli and Giannini conclude that increased competition is the key
to enhancing both operative and allocative efficiency, so the property
of local banks should be made contestable to reduce external banks'
informational disadvantage. The Southern financial sector's cost
efficiency and screening abilities may be improved by encouraging bank
mergers and reducing the separation between commercial banks and special
credit institutions. The current upper limits on interest rates for
long-term loans, which discourage the financing of riskier projects,
should also be abolished.
Finance and Development: The Case of Southern Italy
Riccardo Faini, Giampaolo Galli and Curzio Giannini
Discussion Paper No. 674, July 1992 (IM)