If default information is spread rapidly bad behaviour is punished screening

If default information is spread rapidly bad

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- If default information is spread rapidly, bad behaviour is punished ± screening. Adverse selection and rationing - High-risk vs. low-risk borrowers; adverse selection (information asymmetries). - See model; safe and risky formulas. - As a result of increasing the interest rate your customers will be more risky. Zie slides voor extra uitleg. Group lending Micro finance institutions lend to groups Groups form by themselves, they know what types others are Are liable for each others default Group Lending reduces credit rationing as a result of adverse selection Assortative matching ensures that risky types and safe types form separate groups Joint liability reduces risk of default for risky borrowers Banks can reduce their interest rate, making it more attractive for safe types to borrow Solutions to deal with these risks: - Group lending: monitoring, joint liability Assertive matching: ensures that risky types and safe types from separate groups Interest rates can be lower because every member has to pay if one defaults (and are then excluded from the market if they don’t). Interlinked credit Pay back in output Often provided by landlord, trader Option in regions where charging interest rates is forbidden Allows to keep more renters in the market as risk of strategic default is reduced Has the same negative incentive effects on effort , as output is taxed ( sharecropping ) Conclusion : Lenders face LL and asymmetric information Strategies 1. Collateral (land titling !) 2. Information : Segmentation, exclusive dealings : repeat lending to fixed clientele (switching costs are high) Interlinked transactions: moneylenders are landlords, traders, shopkeepers Result: interest rate variation plus local monopolies based on information 3. Increase interest rates 4. Reduce loan size to prevent strategic default 5. Interlinked credit 6. Group lending Downloaded by Vicky Gupta ([email protected]) lOMoARcPSD|3929542
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Empirical validation Default = function (interest rate charged) Positive relation could be due to Moral Hazard Defaulting becomes more attractive relative to paying back loan Increase collateral requirements, promote dynamic incentives Adverse selection More riskier borrowers apply if interest rate is high Loan guarantees, advanced screening, subsidize loans As interest rate increases, chance of default increases (can be due to; moral hazard or adverse selection). Consumer credit field experiment Adverse selection is something that happens before you apply for the loan. Moral hazard happens after you have applied for the loan. They split up these two steps on their experiment to isolate which imperfection plays a larger part in defaults for small loans. Dynamic incentive had the most effect on default.
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