Working Paper: CEPR ID: DP2439
Authors: Michael Manove; Jorge Padilla; Marco Pagano
Abstract: Many economists argue that the primary economic function of banks is to provide cheap credit, and to facilitate this function, they advocate the strict protection and enforcement of creditor rights. But banks can serve another important economic function: through project screening they can reduce the number of project failures and thus mitigate their private and social costs. Strict protection of creditor rights leaves the tradeoff between these two banking functions to the market. In this paper, we show that because of market imperfections in the banking industry, strong creditor protection may lead to market equilibria in which cheap credit is inappropriately emphasized over project screening. Restrictions on collateral requirements and the protection of debtors in bankruptcy proceedings may redress this imbalance and increase credit-market efficiency.
Keywords: collateral; screening; banks; creditor rights
JEL Codes: D80; G20; K20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| strong creditor protection (G33) | decreased project screening (H43) |
| decreased project screening (H43) | increased project failures and social costs (H43) |
| strong creditor protection (G33) | increased project failures and social costs (H43) |
| high competition among banks (G21) | decreased project screening (H43) |
| monopolistic banks (G21) | efficient outcomes (D61) |
| strong creditor protection (G33) | reliance on collateral (G33) |
| reliance on collateral (G33) | inefficient lending practices (G21) |
| limiting creditor rights (G33) | enhance overall economic efficiency (D61) |