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Regulating Exclusion from Financial Markets

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  • PHILIP BOND
  • ARVIND KRISHNAMURTHY
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    Abstract

    We study optimal enforcement in credit markets in which the only threat facing a defaulting borrower is restricted access to financial markets. We solve for the optimal level of exclusion, and link it to observed institutional arrangements. Regulation in this environment must accomplish two objectives. First, it must prevent borrowers from defaulting on one bank and transferring their resources to another bank. Second, and less obviously, it must give banks the incentive to make sizeable loans, and to honour their promises of future credit. We establish that the optimal regulation resembles observed laws governing default on debt. Moreover, if debtors have the right to a "fresh start" after bankruptcy then this must be balanced by enforceable provisions against fraudulent conveyance. Our optimal regulation is robust, in that it can be implemented in a way that does not require the regulator to have information about either the borrower or lender. Our results isolate the way in which specific institutions surrounding bankruptcy-namely rules governing asset garnishment and fraudulent conveyances-support loan markets in which borrowers have no collateral. Copyright 2004 The Review of Economic Studies Ltd.

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    Bibliographic Info

    Article provided by Wiley Blackwell in its journal The Review of Economic Studies.

    Volume (Year): 71 (2004)
    Issue (Month): (07)
    Pages: 681-707

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    Handle: RePEc:bla:restud:v:71:y:2004:i::p:681-707

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    Cited by:
    1. Ronel Elul & Piero Gottardi, 2011. "Bankruptcy: is it enough to forgive or must we also forget?," Working Papers 11-14, Federal Reserve Bank of Philadelphia.
    2. DE LA CROIX, David & MICHEL, Philippe, 2004. "Education and growth with endogenous debt constraints," CORE Discussion Papers 2004074, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    3. Thomas Philippon & Vasiliki Skreta, 2011. "Optimal Interventions in Markets with Adverse Selection," Working Papers 11-11, New York University, Leonard N. Stern School of Business, Department of Economics.
    4. Mitxeo Grajirena, Jone & Mendizabal Zubeldia, Alaitz & Zubia Zubiaurre, Marian & Vidal Iturrioz, Joana, . "Banku-etikoa: finantza bazterketaren irtenbide posiblea," Revista de Dirección y Administración de Empresas, Universidad del País Vasco - Escuela Universitaria de Estudios Empresariales de San Sebastián.
    5. Brown, Martin & Serra-García, Marta, . "The Threat of Exclusion and Relational Contracting," Working Papers on Finance 1407, University of St. Gallen, School of Finance.
    6. Eric Van Tassel, 2009. "Moral Hazard and Capital Requirements in a Lending Model of Credit Denial," Working Papers 09003, Department of Economics, College of Business, Florida Atlantic University.
    7. Marco Realdon, 2007. "Valuation of the Firm's Liabilities When Equity Holders Are Also Creditors," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 34(5-6), pages 950-975.
    8. Langberg, Nisan, 2008. "Optimal financing for growth firms," Journal of Financial Intermediation, Elsevier, vol. 17(3), pages 379-406, July.
    9. Maria Sarigiannidou & Theodore Palivos, 2012. "A Modern Theory of Kuznets’ Hypothesis," Working Papers 201202, Texas Christian University, Department of Economics.
    10. Bond, Philip & Rai, Ashok S., 2009. "Borrower runs," Journal of Development Economics, Elsevier, vol. 88(2), pages 185-191, March.

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