Munich Personal RePEc Archive

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.

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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.

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