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Collateral vs. Project Screening: a Model of Lazy Banks

  • Manove, M.
  • Padilla, A.J.
  • Pagano, M.

Many economists argue that the primary economic function of banks is to provide cheap credit, and to facilitate this function, they advocate the strict protection and enforcement of creditor rights. But banks can serve another important economic function: through project screening they can reduce the number of project failures and thus mitigate their private and social costs. Strict protection of creditor rights would leave the tradeoff between these two banking functions to the market. In this paper, we show that because of market imperfections in the banking industry, strong creditor protection may lead to market equilibria in which cheap credit is inappropriately emphasized over project screening. Restrictions on collateral requirements and the protection of debtors in bankruptcy proceedings may redress this imbalance and increase credit-market efficiency.

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Paper provided by Centro de Estudios Monetarios Y Financieros- in its series Papers with number 9807.

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Length: 32 pages
Date of creation: 1998
Date of revision:
Handle: RePEc:fth:cemfdt:9807
Contact details of provider: Postal: Centro de Estudios Monetarios Y Financieros. Casado del Alisal, 5-28014 Madrid, Spain.
Phone: 914290551
Fax: 914291056
Web page: http://www.cemfi.es/
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