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Banking Regulation and Collateral Screening in a Model of Information Asymmetry

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  • Benjamin Hemingway

    (Bank of Lithuania
    Vilnius University)

Abstract

This paper explores the impact of banking regulation on a competitive credit market with ex-ante asymmetric information and aggregate uncertainty. I construct a model where the government imposes a regulatory constraint that limits the losses banks make in the event of their default. I show that the addition of banking regulation results in three deviations from the standard theory. First, collateral is demanded of both high and low risk firms, even in the absence of asymmetric information. Second, if banking regulation is sufficiently strict, there may not exist an adverse selection problem. Third, a pooling Nash equilibrium can exist.

Suggested Citation

  • Benjamin Hemingway, 2022. "Banking Regulation and Collateral Screening in a Model of Information Asymmetry," Journal of Financial Services Research, Springer;Western Finance Association, vol. 61(3), pages 367-405, June.
    • Handle: RePEc:kap:jfsres:v:61:y:2022:i:3:d:10.1007_s10693-021-00357-w
    DOI: 10.1007/s10693-021-00357-w
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    More about this item

    Keywords

    Banking; Adverse selection; Collateral; Banking regulation;
    All these keywords.

    JEL classification:

    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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