Collateral and bank screening as complements: A spillover effect

Sonny Biswas

Journal of Economic Theory, 2023, vol. 212, issue C

Abstract: I analyze a novel spillover effect from collateralized to uncollateralized loans. High-type borrowers have good projects, while low-type borrowers do not know their project quality. High-type borrowers post collateral, and a monopolist bank screens only low-type borrowers' projects. Different from existing models, equilibrium collateral requirements are stricter than the minimum necessary to achieve separation, even if collateral is costly. When high-type borrowers post more collateral, the bank charges a higher interest rate to low-type borrowers. This, in turn, enhances the bank's incentives to screen the low-types' projects, thereby improving the average quality of uncollateralized loans.

Keywords: Collateral; Bank screening; Adverse selection; Countervailing incentives (search for similar items in EconPapers)
JEL-codes: D82 G21 (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jetheo:v:212:y:2023:i:c:s0022053123000996

DOI: 10.1016/j.jet.2023.105703

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