Working Paper: NBER ID: w20365
Authors: Kinda Hachem
Abstract: Financial intermediaries devote resources to finding and screening borrowers before lending capital. By retaining only sufficiently good matches, informed lenders exacerbate adverse selection problems for others lending in the same market. Failure to internalize this implies that informed lenders are too selective in the matches they retain. The resulting under-use of capital pushes the cost of capital down, decreasing the benefit of being informed rather than uninformed and prompting a reallocation of resources from screening to matching. Compared to the constrained efficient allocation, the decentralized equilibrium has too little screening, too little informed credit, and too much uninformed credit.
Keywords: Screening; Adverse Selection; Financial Intermediation; Walrasian Markets
JEL Codes: D62; D83; E44
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Informed lenders' retention decisions (G21) | Adverse selection (D82) |
| Retention of high-quality matches by informed lenders (G21) | Decrease in overall capital utilization (G31) |
| Underuse of capital (E22) | Decrease in the benefit of being informed (D83) |
| Underuse of capital (E22) | Price of capital down (G31) |
| Decentralized equilibrium has too little screening (D59) | Misallocation of resources (D61) |