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Take the Money and Run: Making Profi ts by Paying Borrowers to Stay Home

Author

Listed:
  • Giuseppe Coco

    (Università degli studi di Firenze)

  • David De Meza

    (London School of Economics)

  • Giuseppe Pignataro

    (Università degli studi di Bologna)

  • Francesco Reito

    (Università degli studi di Catania)

Abstract

Can a bank increase its profi t 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 profi ts, good borrowers bene fit 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

  • Giuseppe Coco & David De Meza & Giuseppe Pignataro & Francesco Reito, 2012. "Take the Money and Run: Making Profi ts by Paying Borrowers to Stay Home," Working Papers - Economics wp2012_27.rdf, Universita' degli Studi di Firenze, Dipartimento di Scienze per l'Economia e l'Impresa.
    • Handle: RePEc:frz:wpaper:wp2012_27.rdf
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    References listed on IDEAS

    as
    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.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Credit market; Screening; Subsidy;
    All these keywords.

    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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