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Take the money and run: making profits by paying borrowers to stay home

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Listed:
  • G. Coco
  • D. De Meza
  • G. Pignataro
  • F. Reito

Abstract

Can a bank increase its profit by subsidizing inactivity? This paper suggests this may occur, due to the presence of hidden information, in a monopolistic credit market. Rather than offering credit in a pooling contract, a monopolist bank can sort borrowers through an appropriate subsidy to inactivity. Under some conditions, sorting may avoid the collapse of the market and increases the welfare of everybody. The bank increases its profits, good borrowers benefit from lower interest rates and bad potential borrowers from the subsidy. The subsidy policy however implies a cross subsidy between contracts and this is possible only under monopoly.

Suggested Citation

  • G. Coco & D. De Meza & G. Pignataro & F. Reito, 2013. "Take the money and run: making profits by paying borrowers to stay home," Working Papers wp861, Dipartimento Scienze Economiche, Universita' di Bologna.
    • Handle: RePEc:bol:bodewp:wp861
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    References listed on IDEAS

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    1. Giuseppe Coco, 2000. "On the Use of Collateral," Journal of Economic Surveys, Wiley Blackwell, vol. 14(2), pages 191-214, April.
    2. de Meza, David & Webb, David, 2000. "Does credit rationing imply insufficient lending?," Journal of Public Economics, Elsevier, vol. 78(3), pages 215-234, November.
    3. George A. Akerlof, 1970. "The Market for "Lemons": Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 84(3), pages 488-500.
    4. Gruner, Hans Peter, 2003. "Redistribution as a selection device," Journal of Economic Theory, Elsevier, vol. 108(2), pages 194-216, February.
    5. Beck, Thorsten & Demirguc-Kunt, Asli & Levine, Ross, 2006. "Bank concentration, competition, and crises: First results," Journal of Banking & Finance, Elsevier, vol. 30(5), pages 1581-1603, May.
    6. David de Meza & David C. Webb, 1987. "Too Much Investment: A Problem of Asymmetric Information," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 102(2), pages 281-292.
    7. Innes, Robert, 1991. "Investment and government intervention in credit markets when there is asymmetric information," Journal of Public Economics, Elsevier, vol. 46(3), pages 347-381, December.
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    More about this item

    JEL classification:

    • D60 - Microeconomics - - Welfare Economics - - - General
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • H71 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Taxation, Subsidies, and Revenue

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