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Special issue: Financial contracting: Theory and evidence



Lending to uncreditworthy borrowers Rajdeep Sengupta ⇑,1 Federal Reserve Bank of Kansas City, 1 Memorial Dri a r t i c l e i n f o Article history: Received 17 October 2011 Available online 20 July 2013 Keywords: Bank competition Credit allocation Traditional theories of financial intermediation typically assume that borrowers are ho neous, especially in terms of opportunities outside the lending relationship. Such assum ⇑ Fax: +1 816 881 2135. E-mail address: [email protected] 1 Thanks to Eric Bond, Martin Brown, Andrew Daughety, George Fortier, Tom Jackman, Esa Jokivuolle, Georg Keienberg, Aksel Mjos, Steven Ongena, Sangsoo Park, Jennifer Reinganum, Suresh Sundaresan, and David Wheelock for their comments and suggestions. The views expressed herein are those of the author and do not necessarily represent those of the Federal Reserve Bank of Kansas City or the Federal Reserve System. All errors are my own. J. Finan. Intermediation 23 (2014) 101–128 Contents lists available at ScienceDirect J. Finan. Intermediation journal homepage: www.elsevier .com/locate/ jfi 1042-9573/$ - see front matter � 2013 Elsevier Inc. All rights reserved. 1. Introduction moge- ptions competitive, lenders are more likely to resort to pooling. This paper also rationalizes the phenomenon of cream-skimming by outside (foreign) lenders as an equilibrium of the model. Surprisingly, we find that the presence of an informed rival actually facilitates cream-skimming by an uninformed lender. � 2013 Elsevier Inc. All rights reserved. Lending standards ve, Kansas City, MO 64198, United States a b s t r a c t We study optimal lending behavior in situations where borrowers’ outside options increase with their creditworthiness. Creditworthi- ness is private information of borrowers. Lenders use collateral as a screening mechanism to address this adverse selection problem. A lender seeking to attract creditworthy borrowers with high

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