Predatory Lending

Rodrigue Mendez

Working Papers from HAL

Abstract: This paper studies the equilibrium predatory practices that may arise when the borrowers have behavioral weaknesses. Rational lenders offer short term contracts that can be renewed at the cost of paying a penalty fee. We show how the optimal contracts depend on the degree of näıvet ́e of the time inconsistent customers. Penalty fees have a dual role : they increase market share by providing a useful commitment device to time-inconsistent but otherwise rational borrowers ; they are also a source of revenue from the semi-naïve borrowers who understand the need for commitment but fail to forecast their future time discount factor. We also show that perfect com- petition does not eliminate predatory practices, since the equilibrium contract entails a subsidized (below marginal cost) short-term loan that can only be profitable if a fraction of the borrowers end up paying the penalty fee.

Keywords: hyperbolic discounting; time inconsistency; sophistication; partial naï vet e; exploitative contracts; credit cards (search for similar items in EconPapers)
Date: 2012
Note: View the original document on HAL open archive server: https://hal.univ-lille.fr/hal-00991948v1
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