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

Author

Listed:
  • 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.

Suggested Citation

  • Giuseppe Coco & David De Meza & Giuseppe Pignataro & Francesco Reito, 2012. "Take the Money and Run: Making Profi ts by Paying Borrowers to Stay Home," Working Papers - Economics wp2012_27.rdf, Universita' degli Studi di Firenze, Dipartimento di Scienze per l'Economia e l'Impresa.
    • Handle: RePEc:frz:wpaper:wp2012_27.rdf
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    JEL classification:

    • D60 - Microeconomics - - Welfare Economics - - - General
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • H71 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Taxation, Subsidies, and Revenue

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