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Collateral vs. Project Screening: A Model of Lazy Banks

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Abstract

Many argue that the primary function of banks is to provide cheap credit, and to this effect advocate strict protection of creditor rights. But banks serve another important function: through project screening, they can improve the allocation of capital across projects. In this paper we show that, in the presence of informational asymmetries, strong creditor protection may lead to competitive market equilibria where banks, protected by high collateral, perform an inefficiently low level of screening. Restrictions on collateral requirements and protection of debtors in bankruptcy may thus increase credit market efficiency.

Suggested Citation

  • Michael Manove & A. Jorge Padilla & Marco Pagano, 1998. "Collateral vs. Project Screening: A Model of Lazy Banks," CSEF Working Papers 10, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
  • Handle: RePEc:sef:csefwp:10
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    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • G2 - Financial Economics - - Financial Institutions and Services
    • K2 - Law and Economics - - Regulation and Business Law

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