Working Paper: CEPR ID: DP5410
Authors: Roman Inderst
Abstract: We present a simple model of household (or consumer) lending in which, building on past information and local expertise, an incumbent lender has an information advantage both vis-a-vis potential competitors and households. We show that if the adverse selection problem faced by other lenders is sufficiently severe, the incumbent preserves his monopoly power and may engage in too aggressive lending. The incumbent lender may then approve credit even against a household?s best interest. In contrast, with effective competition it may now be less informed lenders who lend too aggressively to households who were rejected by the incumbent, though this only occurs if households 'naively' ignore the information contained in their previous rejection. We find that competition may also distort lending as less informed lenders try to free ride on the incumbent?s superior screening ability.
Keywords: Consumer and Personal Finance; Irresponsible Lending Practices; Predatory Lending
JEL Codes: G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| incumbent lender's informational advantage (G21) | aggressive lending practices (G21) |
| aggressive lending practices (G21) | detrimental to household's welfare (D10) |
| incumbent lender's monopoly power (D42) | extraction of consumer surplus (D11) |
| competition from less informed lenders (G21) | more aggressive lending (G21) |
| lack of awareness among households about rejection by incumbent (D19) | willingness to accept loans from less informed lenders (G51) |
| less informed lenders' loans (G21) | detrimental to household's welfare (D10) |