WILLFUL DEFAULT IN DEVELOPING COUNTRY BANKING SYSTEM: A THEORETICAL EXERCISE

Samaresh Bardhan () and Vivekananda Mukherjee
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Samaresh Bardhan: Indian Institute of Technology, Ropar, India

Journal of Economic Development, 2013, vol. 38, issue 4, 101-121

Abstract: We construct a sequential game to highlight the incidence of 'willful default' in a developing country banking system where the borrowing unit underreports its true financial position and defaults willfully. Specifically, the paper deals with the implications of willful default for profitability and ultimate loan decision-making process of the banks. It shows that if limited liability condition holds and the conditions of willful default are satisfied, the bank will extend maximum possible amount of loan. However, it also follows that higher the loan capacity of the bank, the higher is the incidence of willful default. These would imply important policy lessons for the regulator. In fact, the regulator faces a trade-off between higher incidence of willful default and higher profitability of the bank. What we observe in reality depends on the objective of the regulator.

Keywords: Commercial Banks; Loan Default; Bank Regulation (search for similar items in EconPapers)
JEL-codes: G20 G21 G28 (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:jed:journl:v:38:y:2013:i:4:p:101-121

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