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Consumer Lending When Lenders are More Sophisticated Than Households

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Author Info
Inderst, Roman
Abstract

We present a simple model of household (or consumer) lending in which, building on past information and local expertise, an incumbent lender has an information advantage both vis-a-vis potential competitors and households. We show that if the adverse selection problem faced by other lenders is sufficiently severe, the incumbent preserves his monopoly power and may engage in too aggressive lending. The incumbent lender may then approve credit even against a household’s best interest. In contrast, with effective competition it may now be less informed lenders who lend too aggressively to households who were rejected by the incumbent, though this only occurs if households 'naively' ignore the information contained in their previous rejection. We find that competition may also distort lending as less informed lenders try to free ride on the incumbent’s superior screening ability.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5410.

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Date of creation: Jan 2006
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Handle: RePEc:cpr:ceprdp:5410

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Keywords: consumer and personal finance; irresponsible lending practices; predatory lending;

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G1 - Financial Economics - - General Financial Markets

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  6. Wang, H.J. & White, M., 1998. "An Optimal Personal Bankruptcy Procedure and Proposed Reform," Papers 98-07, Michigan - Center for Research on Economic & Social Theory.
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  7. Martin Ruckes, 2004. "Bank Competition and Credit Standards," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 17(4), pages 1073-1102. [Downloadable!] (restricted)
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  10. Richard Hynes & Eric A. Posner, 2002. "The Law and Economics of Consumer Finance," American Law and Economics Review, Oxford University Press, vol. 4(1), pages 168-207, January.
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  13. Baumol, William J & Willig, Robert D, 1981. "Fixed Costs, Sunk Costs, Entry Barriers, and Sustainability of Monopoly," The Quarterly Journal of Economics, MIT Press, vol. 96(3), pages 405-31, August. [Downloadable!] (restricted)
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  15. A. Rampini, Adriano, 2005. "Default and aggregate income," Journal of Economic Theory, Elsevier, vol. 122(2), pages 225-253, June. [Downloadable!] (restricted)
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