Resource Allocation and Inefficiency in the Financial Sector
I analyze whether banks are efficient at allocating resources across intermediation activities. Competition between lenders means that resources are needed to draw borrowers into credit matches. At the same time, imperfect information between lenders and borrowers means that resources are also needed for screening. I show that the privately optimal allocation of resources is constrained inefficient. In particular, too many resources are spent on getting rather than vetting borrowers but, once properly vetted, not enough matches are retained. Uninformed lending is thus inefficiently high, informed lending is inefficiently low, and a tax on matching activities helps remedy the situation.
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2011-WP-13, Indiana State University, Scott College of Business, Networks Financial Institute.
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- Gehrig, Thomas & Stenbacka, Rune, 2011. "Decentralized screening: Coordination failure, multiple equilibria and cycles," Journal of Financial Stability, Elsevier, vol. 7(2), pages 60-69, June.
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