Moral Hazard and Capital Requirements in a Lending Model of Credit Denial

Eric Van Tassel ()

No 9003, Working Papers from Department of Economics, College of Business, Florida Atlantic University

Abstract: In this paper we analyze a repeated game in which an intermediary offers unsecured loans to entrepreneurs using future credit denial to induce repayment. To finance the loans, the intermediary uses a combination of equity capital and external funds. We focus on a moral hazard problem that emerges between the intermediary and the less informed external investors over a costly loan monitoring choice. The presence of informed borrowers in the lender’s portfolio turns out to act as a substitute for capital requirements. The result is that the lending strategy utilized by the intermediary minimizes the moral hazard problem but implies the intermediary’s balance sheet is fragile to exogenous risk.

Keywords: Moral hazard; Capital requirements; Bank regulation; Repayment incentives (search for similar items in EconPapers)
JEL-codes: G21 G28 O16 (search for similar items in EconPapers)
Pages: 32 pages
Date: 2009-05
New Economics Papers: this item is included in nep-ban, nep-bec, nep-cfn, nep-cta, nep-mfd and nep-reg
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Persistent link: https://EconPapers.repec.org/RePEc:fal:wpaper:09003

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