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Willful Default In Developing Country Banking System: A Theoretical Exercise

Author

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  • SAMARESH BARDHAN

    (Indian Institute of Technology, Ropar, India)

  • VIVEKANANDA MUKHERJEE

    (Jadavpur University, India)

Abstract

We construct a sequential game to highlight the incidence of 'willful default' in a developing country banking system where the borrowing unit underreports its true financial position and defaults willfully. Specifically, the paper deals with the implications of willful default for profitability and ultimate loan decision-making process of the banks. It shows that if limited liability condition holds and the conditions of willful default are satisfied, the bank will extend maximum possible amount of loan. However, it also follows that higher the loan capacity of the bank, the higher is the incidence of willful default. These would imply important policy lessons for the regulator. In fact, the regulator faces a trade-off between higher incidence of willful default and higher profitability of the bank. What we observe in reality depends on the objective of the regulator.

Suggested Citation

  • Samaresh Bardhan & Vivekananda Mukherjee, 2013. "Willful Default In Developing Country Banking System: A Theoretical Exercise," Journal of Economic Development, Chung-Ang Unviersity, Department of Economics, vol. 38(4), pages 101-121, December.
    • Handle: RePEc:jed:journl:v:38:y:2013:i:4:p:101-121
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    References listed on IDEAS

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    Cited by:

    1. Samaresh Bardhan & Vivekananda Mukherjee, 2016. "Bank-specific determinants of nonperforming assets of Indian banks," International Economics and Economic Policy, Springer, vol. 13(3), pages 483-498, July.

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    More about this item

    Keywords

    Commercial Banks; Loan Default; Bank Regulation;
    All these keywords.

    JEL classification:

    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • 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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