Collateral vs. Project Screening: A Model of Lazy Banks

RAND Journal of Economics, Vol. 32, No. 4, Winter, 2001

CSEF WORKING PAPER No. 10

22 Pages Posted: 1 Dec 1998 Last revised: 30 Dec 2010

See all articles by Michael Manove

Michael Manove

Boston University - Department of Economics

Jorge Padilla

Compass Lexecon

Marco Pagano

University of Naples Federico II - Department of Economics and Statistics; Centre for Studies in Economics and Finance (CSEF); Einaudi Institute for Economics and Finance (EIEF); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Date Written: November 1, 1998

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 would leave 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.

JEL Classification: D8, G2, K2

Suggested Citation

Manove, Michael and Padilla, Jorge and Pagano, Marco, Collateral vs. Project Screening: A Model of Lazy Banks (November 1, 1998). RAND Journal of Economics, Vol. 32, No. 4, Winter, 2001. Available at SSRN: https://ssrn.com/abstract=141051 or http://dx.doi.org/10.2139/ssrn.141051

Michael Manove (Contact Author)

Boston University - Department of Economics ( email )

270 Bay State Road
Boston, MA 02215
United States
617-353-3299 (Phone)
617-353-4449 (Fax)

Jorge Padilla

Compass Lexecon ( email )

Paseo de la Castellana 7
Madrid, 28046
Spain

Marco Pagano

University of Naples Federico II - Department of Economics and Statistics ( email )

Via Cintia - Monte S. Angelo
Napoli, 80126
Italy
+39 081 675306 (Phone)
+39 081 7663540 (Fax)

Centre for Studies in Economics and Finance (CSEF) ( email )

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Complesso Monte S. Angelo
Naples, Naples 80126
Italy

Einaudi Institute for Economics and Finance (EIEF)

Via Sallustiana, 62
Rome, 00187
Italy

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http:/www.ecgi.org

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