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Take the Money and Run: Making Profi ts by Paying Borrowers to Stay Home

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  • Giuseppe Coco

    ()
    (Università degli studi di Firenze)

  • David De Meza

    (London School of Economics)

  • Giuseppe Pignataro

    (Università degli studi di Bologna)

  • Francesco Reito

    (Università degli studi di Catania)

Abstract

Can a bank increase its profi t by subsidizing inactivity? This paper suggests this may occur, due to the presence of hidden information, in a monopolistic credit market. Rather than offering credit in a pooling contract, a monopolist bank can sort borrowers through an appropriate subsidy to inactivity. Under some conditions, sorting may avoid the collapse of the market and increases the welfare of everybody. The bank increases its profi ts, good borrowers bene fit from lower interest rates and bad potential borrowers from the subsidy. The subsidy policy however implies a cross subsidy between contracts and this is possible only under monopoly.

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Bibliographic Info

Paper provided by Universita' degli Studi di Firenze, Dipartimento di Scienze per l'Economia e l'Impresa in its series Working Papers - Economics with number wp2012_27.rdf.

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Length: 18 pages
Date of creation: 2012
Date of revision:
Handle: RePEc:frz:wpaper:wp2012_27.rdf

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Keywords: Credit market; Screening; Subsidy;

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  1. Beck, T.H.L. & Demirgüç-Kunt, A. & Levine, R., 2006. "Bank concentration, competition, and crises: First results," Open Access publications from Tilburg University urn:nbn:nl:ui:12-3125498, Tilburg University.
  2. Akerlof, George A, 1970. "The Market for 'Lemons': Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, MIT Press, vol. 84(3), pages 488-500, August.
  3. de Meza, David & Webb, David, 2000. "Does credit rationing imply insufficient lending?," Journal of Public Economics, Elsevier, vol. 78(3), pages 215-234, November.
  4. Coco, G., 1998. "On the Use of Collateral," Discussion Papers 9805, Exeter University, Department of Economics.
  5. Gruner, Hans Peter, 2003. "Redistribution as a selection device," Journal of Economic Theory, Elsevier, vol. 108(2), pages 194-216, February.
  6. de Meza, David & Webb, David C, 1987. "Too Much Investment: A Problem of Asymmetric Information," The Quarterly Journal of Economics, MIT Press, vol. 102(2), pages 281-92, May.
  7. Innes, Robert, 1991. "Investment and government intervention in credit markets when there is asymmetric information," Journal of Public Economics, Elsevier, vol. 46(3), pages 347-381, December.
  8. Francesco Reito, 2011. "Redistribution, Collateral Subsidy and Screening," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 67(1), pages 8-26, March.
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