Abstract I quantitatively analyse the macroeconomic impacts of raising capital requirements in a model in which heterogeneous firms may choose either intermediated or direct finance. Heterogeneous banks compete with other banks and the bond market, fund loans with insured deposits and costly equity (subject to a minimum capital-to-asset ratio), and monitor borrowers. I find that tighter capital requirements reduce costly bank failures while having only small effects on key macroeconomic aggregates, and that raising capital requirements above current levels can be welfare-improving. Three main forces give rise to these results. First, even though banks cut loan supply for a given level of net worth under a tighter capital requirement, in equilibrium banks’ net worth rises to dampen this effect. Second, intense competition from the non-bank sector disciplines banks’ lending responses to tighter regulation. Third, substitution by corporate firms offsets much of the decline in debt financing associated with tighter bank loan supply. As a corollary, almost all of the modest costs associated with tighter capital requirements are concentrated within the bank-dependent non-corporate sector.

We study the aggregate consequences of dynamic lending relationships in a model of heterogeneous banks facing financial frictions. We estimate the model’s loan demand system on administrative loan-level data: the market power implied by the estimated strength and persistence of relationships yields a long run reduction in credit of 5.9%. Relationships amplify the negative real effects of credit supply shocks, but mute those of negative credit demand shocks. In a financial crisis which destroys 25% of bank net worth, for example, loan volume drops more than twice as much in our baseline model than in a competitive analog with no relationships, but banks recapitalize faster.

What is the role of credit scores in credit markets? We argue that it is, in part, the market's assessment of a person's unobservable type, which here we take to be patience. We postulate a model of persistent hidden types where observable actions shape the public assessment of a person's type via Bayesian updating. We show how dynamic reputation can incentivize repayment. Importantly, we show how an economy with credit scores implements the same equilibrium allocation. We estimate the model using both credit market data and the evolution of individuals' credit scores. We conduct counterfactuals to assess how more or less information used in scoring individuals affects outcomes and welfare. If tracking of individual credit actions is outlawed, poor young adults of low type benefit from subsidization by high types despite facing higher interest rates arising from lower dynamic incentives to repay.