What Does Excess Bank Liquidity Say About the Loan Market in Less Developed Countries?

Evidence about commercial banks' liquidity preference says the following about the loan market in less developed countries (LDCs): (i) the loan interest rate is a minimum mark-up rate; (ii) the loan market is characterized by oligopoly power; and (iii) indirect monetary policy, a cornerstone of financial liberalization, can only be effective at very high interest rates that are likely to be deflationary. The minimum rate is a mark-up over an exogenous foreign interest rate, marginal transaction costs, and a risk premium. In order to present its case, the paper utilizes and extends the oligopoly model of the banking firm. A calibration exercise demonstrates that the hypothesis of a minimum mark-up loan rate is largely consistent with the observed stylized facts of flat liquidity preferences