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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

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.

Suggested Citation

  • Staten, Michael E & Gilley, Otis W & Umbeck, John, 1990. "Information Costs and the Organization of Credit Markets: A Theory of Indirect Lending," Economic Inquiry, Western Economic Association International, vol. 28(3), pages 508-529, July.
  • Handle: RePEc:oup:ecinqu:v:28:y:1990:i:3:p:508-29
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    References listed on IDEAS

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    1. Feldstein, Martin & Liebman, Jeffrey B., 2002. "Social security," Handbook of Public Economics,in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 4, chapter 32, pages 2245-2324 Elsevier.
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    Cited by:

    1. Tseng, Jauling, 1996. "Farmer-borrowers' selection of short- and intermediate-term loan contracts: traditional lenders versus nontraditional lenders," ISU General Staff Papers 1996010108000012129, Iowa State University, Department of Economics.
    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. 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.
    4. 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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