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Information Costs and the Organization of Credit Markets: A Theory of Indirect Lending

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  • Staten, Michael E
  • Gilley, Otis W
  • Umbeck, John
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    Abstract

    This paper explains indirect lending as a strategy for reducing a bank's cost of screening borrowers. Commercial banks appear to "ration" credit by rejecting some direct loan applicants, although they accept higher-risk borrowers who apply for loans indirectly through retailers. However, the more thorough credit check on direct loans causes applicants to sort themselves according to risk. Indirect applicants signal their higher risk through their choice of financing. Since banks gather more accurate information on direct applicants, the two types of contracts should differ in predictable ways. These implications are tested with Federal Reserve data on 5,000 automobile loans. Copyright 1990 by Oxford University Press.

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    Bibliographic Info

    Article provided by Western Economic Association International in its journal Economic Inquiry.

    Volume (Year): 28 (1990)
    Issue (Month): 3 (July)
    Pages: 508-29

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    Handle: RePEc:oup:ecinqu:v:28:y:1990:i:3:p:508-29

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    Cited by:
    1. Lown, Cara & Peristiani, Stavros, 1996. "The behavior of consumer loan rates during the 1990 credit slowdown," Journal of Banking & Finance, Elsevier, vol. 20(10), pages 1673-1694, December.
    2. Michael E. Staten & John M. Barron & Andrew B. Chong, 2004. "The Emergence of Captive Finance Companies and Risk Segmentation of the Consumer Loan Market:Theory and Evidence," Econometric Society 2004 Far Eastern Meetings 584, Econometric Society.
    3. Amy Cutts & Robert Order, 2004. "On the Economics of Subprime Lending," The Journal of Real Estate Finance and Economics, Springer, vol. 30(2), pages 167-196, November.

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