Financing the newsvendor: raising the loan limit by insurance contract

Banks often control their risks to be below a risk limit through setting a loan limit and the capital constrained newsvendor can make the loan limit increase by buying a guarantee insurance policy. This paper examines the impact of a bank’s risk limit, interest rate setting and initial capital on the newsvendor’s financial and ordering decisions with deductible insurance contract. In the perfectly competitive bank market, it is shown that the newsvendor will restore his profit to the optimal level without capital constraint by buying a full insurance. In the regulated monopolistic bank market, the newsvendor only buys insurance when both his initial capital and the bank’s risk limit are low; for a poorer newsvendor, the bank should require a lower risk limit to force the newsvendor to buy insurance, not just to meet regulatory requirements. It is also shown that the insurance is more useful for a poor newsvendor and a more risk-averse bank.