DP5410 Consumer Lending When Lenders are More Sophisticated Than Households
|Publication Date:||January 2006|
|Keyword(s):||consumer and personal finance, irresponsible lending practices, predatory lending|
|Programme Areas:||Financial Economics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=5410|
We present a simple model of household (or consumer) lending in which, building on past information and local expertise, an incumbent lender has an information advantage both vis-a-vis potential competitors and households. We show that if the adverse selection problem faced by other lenders is sufficiently severe, the incumbent preserves his monopoly power and may engage in too aggressive lending. The incumbent lender may then approve credit even against a household?s best interest. In contrast, with effective competition it may now be less informed lenders who lend too aggressively to households who were rejected by the incumbent, though this only occurs if households 'naively' ignore the information contained in their previous rejection. We find that competition may also distort lending as less informed lenders try to free ride on the incumbent?s superior screening ability.