The social cost of playing by the rules in the credit market

Distefano, Rosaria (2022): The social cost of playing by the rules in the credit market.

Abstract

We present a model of the credit market under imperfect information, with a lender and many would-be entrepreneurs who need external funding for their projects. Some borrowers may have the incentive to divert part of the loan received to other, illegal or non-contractible, uses. We first show that the equilibrium is more likely to be efficient when there is a high proportion of potential diverters. Another result is that, if diversion output is included in the social well-being function, equilibrium welfare can be higher than under symmetric information. When there is inefficiency, a regulatory intervention can be welfare improving but, the cost and desirability of the policy depend on whether the proceeds from diversion are classified as a contribution to social welfare or not.

• Item Type: MPRA Paper
• Language: English
• Keywords: loan diversion; entrepreneurial financing; imperfect information; policy intervention.
• Subjects: D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D82 - Asymmetric and Private Information ; Mechanism Design; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E50 - General

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