Working Paper: CEPR ID: DP5695
Authors: Roman Inderst; Holger M. Mueller
Abstract: We consider an imperfectly competitive loan market in which a local (e.g., relationship) lender has valuable soft, albeit private, information, which gives her a competitive advantage vis-à-vis distant transaction lenders who provide arm?s-length financing based on hard, publicly available information. The competitive pressure from transaction lenders forces the local lender to leave surplus to borrowers, which distorts the local lender?s credit decision in the sense that she inefficiently rejects marginally profitable projects. Collateral mitigates this inefficiency by 'flattening' the local lender?s payoff function, thus improving her payoff from precisely those projects that she inefficiently rejects. Our model predicts that technological innovations such as small business credit scoring that narrow the information advantage of local lenders vis-à-vis transaction lenders lead to higher collateral requirements, thus strengthening the role of collateral in local lending relationships.
Keywords: Collateral; Relationship Lending vs Transaction Lending; Soft Information
JEL Codes: G21; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| narrowing of information advantages (D83) | higher collateral requirements (G21) |
| collateral mitigates inefficiencies in credit decisions (D61) | better credit decisions (G51) |
| local lender's information advantages (G21) | collateral requirements (G32) |
| borrowers located further from local lender (G21) | higher collateral requirements (G21) |
| borrowers without existing relationships (G51) | higher collateral requirements (G21) |