Credit Allocation When Private Banks Distribute Government Loans

We study bank lending when private banks distribute subsidized loans. In Brazil, private banks operate in two credit markets: a competitive free market and an earmarked market characterized by government-funded loans at below-market interest rates. We find that banks are more likely to extend earmarked loans to larger firms and firms with existing relationships. We further document a novel cross-selling strategy whereby banks increase the price of free-market loans for riskier borrowers that obtain earmarked credit. JEL Classification: G21, H81, E43