Serving the (Un)Deserving? The Allocation of Credit in Markets with Asymmetrically Informed Lenders

Historical examinations of credit markets provide ample evidence on the coexistence of a variety of banking models, some of which specialize in information-intensive business practices. This paper studies the operation of markets in which asymmetrically informed lenders compete for investment projects with stochastic returns. We explore how the business model underlying informed lending — profit maximization (e.g. for profit relational lenders) vs. inter-member surplus redistribution (e.g. credit cooperatives) — shapes relative comparative advantages and affects market efficiency. Three findings stand out. First, consistent with real world evidence, a variety of market configurations — in terms of e.g. credit volumes and market shares — may obtain in equilibrium. Second, market failures (overlending) always prove mitigated when both types of lenders are operative, relative to a world in which equally uninformed lenders only populate the banking landscape. Third, market interaction between asymmetrically informed lenders can generate multiple equilibria. Hence, small changes in the business conditions or other fundamentals can cause large shifts in the allocation of credit leading to either highly selective markets or ones which rather endorse credit provision to undeserving entrepreneurs.