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Inter-Temporal Calculative Trust Design to Reduce Collateral Need for Business Credits

Muduli, Silu and Dash, Shridhar Kumar (2018): Inter-Temporal Calculative Trust Design to Reduce Collateral Need for Business Credits. Published in: Reserve Bank of India Occasional Papers , Vol. 38, No. 1 and 2 (24 July 2018): pp. 65-83.

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Credit rationing arising out of informational asymmetry and lack of collateral is a well-recognised economic constraint in the credit market. These constraints get magnified for small businesses. This paper attempts to capture the dimension of trustworthiness (calculative trust) by designing a multi-period, incentivised payment structure that will induce economic agents to reveal the existence of private information about any projects or true intentions of paying up the credit that is going to fund the project. The model dynamically estimates the collateral needed by taking into account the truthfulness of the borrower. The proposed design is compared with the benchmark model - credit scoring-based model. Randomized simulations are carried out for the ex ante solution for the borrower. We find that the proposed design outperforms from the perspective of lenders when the probability of default of any project is less than 80 per cent. Our simulation result also finds that building trust helps small business owner to significantly reduce the need for collateral.

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