Selective Outreach and Spillovers from Targeted Interest Rate Caps

Many countries implement interest rate caps that target specific loan segments, reducing their profitability. Whether lenders reallocate credit supply away from targeted segments depends on how borrowers and lenders are matched. This paper studies the credit supply and welfare effects of targeted interest rate caps when lenders selectively reach out to borrowers, a common practice in many settings. Using a reform that tightened interest rate caps on agricultural loans in Ecuador, I show that, consistent with the reallocation prediction, cooperatives reduced agricultural lending and increased non-agricultural lending. By contrast, banks expanded agricultural lending. I develop an empirical model in which lenders allocate supply by selectively extending offers to borrowers. I find that, although all lenders reduced their offers to agricultural borrowers, banks' originations increased because steeper price cuts raised borrower acceptance. Most of the cross-sector supply reallocation and welfare losses in the agricultural sector are due to targeting.