A Lender-Based Theory of Collateral

Roman Inderst and Holger Mueller

No 5695, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We consider an imperfectly competitive loan market in which a local (e.g., relationship) lender has valuable soft, albeit private, information, which gives her a competitive advantage vis-Ã -vis distant transaction lenders who provide arm?s-length financing based on hard, publicly available information. The competitive pressure from transaction lenders forces the local lender to leave surplus to borrowers, which distorts the local lender?s credit decision in the sense that she inefficiently rejects marginally profitable projects. Collateral mitigates this inefficiency by 'flattening' the local lender?s payoff function, thus improving her payoff from precisely those projects that she inefficiently rejects. Our model predicts that technological innovations such as small business credit scoring that narrow the information advantage of local lenders vis-Ã -vis transaction lenders lead to higher collateral requirements, thus strengthening the role of collateral in local lending relationships.

Keywords: Collateral; Soft information; Relationship lending vs transaction lending (search for similar items in EconPapers)
JEL-codes: G21 G32 (search for similar items in EconPapers)
Date: 2006-06
New Economics Papers: this item is included in nep-ban and nep-fin
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (19)

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Journal Article: A lender-based theory of collateral (2007)
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