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Predatory Lending

Author

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  • Rodrigue Mendez

    (EQUIPPE - Economie Quantitative, Intégration, Politiques Publiques et Econométrie - Université de Lille, Sciences et Technologies - Université de Lille, Sciences Humaines et Sociales - PRES Université Lille Nord de France - Université de Lille, Droit et Santé)

Abstract

This paper studies the equilibrium predatory practices that may arise when the borrowers have behavioral weaknesses. Rational lenders offer short term contracts that can be renewed at the cost of paying a penalty fee. We show how the optimal contracts depend on the degree of näıvet ́e of the time inconsistent customers. Penalty fees have a dual role : they increase market share by providing a useful commitment device to time-inconsistent but otherwise rational borrowers ; they are also a source of revenue from the semi-naïve borrowers who understand the need for commitment but fail to forecast their future time discount factor. We also show that perfect com- petition does not eliminate predatory practices, since the equilibrium contract entails a subsidized (below marginal cost) short-term loan that can only be profitable if a fraction of the borrowers end up paying the penalty fee.

Suggested Citation

  • Rodrigue Mendez, 2012. "Predatory Lending," Working Papers hal-00991948, HAL.
    • Handle: RePEc:hal:wpaper:hal-00991948
    Note: View the original document on HAL open archive server: https://hal.univ-lille.fr/hal-00991948
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    References listed on IDEAS

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