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Collateral vs. Project Screening: A Model of Lazy Banks

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Abstract

Many argue that the primary function of banks is to provide cheap credit, and to this effect advocate strict protection of creditor rights. But banks serve another important function: through project screening, they can improve the allocation of capital across projects. In this paper we show that, in the presence of informational asymmetries, strong creditor protection may lead to competitive market equilibria where banks, protected by high collateral, perform an inefficiently low level of screening. Restrictions on collateral requirements and protection of debtors in bankruptcy may thus increase credit market efficiency.

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Paper provided by Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy in its series CSEF Working Papers with number 10.

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Date of creation: 01 Nov 1998
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Publication status: Published in RAND Journal of Economics, Vol. 32, No. 4, Winter, 2001
Handle: RePEc:sef:csefwp:10

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