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Mutual Loan-Guarantee Societies in Monopolistic Credit Markets with Adverse Selection

  • Giovanni Busetta

    ()

    (Universit… di Messina, Department of Economics, Statistics, Mathematics, and Sociology V. Pareto)

  • Alberto Zazzaro

    ()

    (Universit… Politecnica delle Marche, MoFiR)

In many countries, Mutual Loan-Guarantee Societies (MLGSs) are assuming ever-increasing importance for small business lending. In this paper we provide a theory to rationalise the raison d'^etre of MLGSs. The basic intuition is that the foundation for MLGSs lies in the inefficiencies created by adverse selection, when borrowers do not have enough collateralisable wealth to satisfy collateral requirements and induce self-selecting contracts. In this setting, we view MLGSs as a wealth-pooling mechanism that allows otherwise inefficiently rationed borrowers to obtain credit. We focus on the case of large, complex urban economies where potential entrepreneurs are numerous and possess no more information about each other than do banks. Despite our extreme assumption on information availability, we show that MLGSs can be characterized by assortative matching in which only safe borrowers have an incentive to join the mutual society.

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Paper provided by Money and Finance Research group (Mo.Fi.R.) - Univ. Politecnica Marche - Dept. Economic and Social Sciences in its series Mo.Fi.R. Working Papers with number 33.

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Length: 21
Date of creation: Nov 2009
Date of revision:
Handle: RePEc:anc:wmofir:33
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