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Lending to uncreditworthy borrowers

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  • Rajdeep Sengupta
Abstract
This paper models entry and competition in \"high-risk\" credit markets. An incumbent lender's advantage over any outside bank derives from its knowledge of (i) the risk profile of its (creditworthy) clients and (ii) uncreditworthy types in the borrower population. Screening is costly and the uninformed lender's ability to use collateral as a screening mechanism depends on its cost advantage over its informed rival. Nevertheless, the outside bank can pool uncreditworthy borrowers with creditworthy types, but only if it has a low cost of funds. Therefore, while a secular decline in the cost of funds does not help outside banks to screen uncreditworthy borrowers, it allows them to pool these borrowers with creditworthy types. This not only facilitates entry of outside banks into \"high-risk\" credit markets, but also makes it optimal for them to include non-creditworthy borrowers in their loan portfolio. The framework is relevant for explaining the recent entry of outside banks into the \"subprime\"-end of the loan market, for example, loans to the lowest end of small businesses in developing countries - also known as microfinance.

Suggested Citation

  • Rajdeep Sengupta, 2008. "Lending to uncreditworthy borrowers," Working Papers 2007-044, Federal Reserve Bank of St. Louis.
    • Handle: RePEc:fip:fedlwp:2007-044
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    Cited by:

    1. Gabriel Jiménez & Steven Ongena & José‐Luis Peydró & Jesús Saurina, 2014. "Hazardous Times for Monetary Policy: What Do Twenty‐Three Million Bank Loans Say About the Effects of Monetary Policy on Credit Risk‐Taking?," Econometrica, Econometric Society, vol. 82(2), pages 463-505, March.
    2. Chen, Xudong & Yao, Liming & Xu, Zhenye & Xu, Qi, 2018. "Foreign entry and bank competition on financial products in China: A model of bank size," Pacific-Basin Finance Journal, Elsevier, vol. 49(C), pages 43-59.
    3. Gabriel Jiménez & Steven Ongena & José-Luis Peydró & Jesús Saurina, 2017. "“In the Short Run Blasé, In the Long Run Risqué”," Schmalenbach Business Review, Springer;Schmalenbach-Gesellschaft, vol. 18(3), pages 181-226, August.
    4. Lengwiler, Yvan & Rishabh, Kumar, 2017. "Credit from the Monopoly Bank," Working papers 2017/15, Faculty of Business and Economics - University of Basel.
    5. Biswas, Sonny, 2023. "Collateral and bank screening as complements: A spillover effect," Journal of Economic Theory, Elsevier, vol. 212(C).
    6. Jiménez, Gabriel & Ongena, Steven & Peydró, José-Luis & Saurina, Jesús, 2017. "‘In the Short Run Blasé, in the Long Run Risqué’. On the Effects of Monetary Policy on Bank Credit Risk-Taking in the Short versus Long Run," EconStor Open Access Articles and Book Chapters, ZBW - Leibniz Information Centre for Economics, vol. 18(3), pages 181-226.
    7. Uddin, Md Hamid & Akter, Shabiha & Mollah, Sabur & Al Mahi, Masnun, 2022. "Differences in bank and microfinance business models: An analysis of the loan monitoring systems and funding sources," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 80(C).
    8. Samitas, Aristeidis & Polyzos, Stathis & Siriopoulos, Costas, 2018. "Brexit and financial stability: An agent-based simulation," Economic Modelling, Elsevier, vol. 69(C), pages 181-192.
    9. Rishabh, Kumar, 2021. "Bank as a Venture Capitalist," Working papers 2021/09, Faculty of Business and Economics - University of Basel.
    10. Samitas, Aristeidis & Polyzos, Stathis, 2016. "Freeing Greece from capital controls: Were the restrictions enforced in time?," Research in International Business and Finance, Elsevier, vol. 37(C), pages 196-213.

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    Keywords

    Credit control - United States; Bank loans - United States;

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