Mutual Loan-Guarantee Societies in Monopolistic Credit Markets with Adverse Selection

20 Pages Posted: 2 Nov 2009

See all articles by Giovanni Busetta

Giovanni Busetta

University of Messina - Department of Economics, Business, Environmental Sciences and Quantitative Methods

Alberto Zazzaro

Polytechnic University of Marche - Faculty of Economics

Date Written: June 1, 2009

Abstract

In many countries, Mutual Loan-Guarantee Societies (MLGSs) are assuming ever-increasing importance for small business lending. In this paper we provide a theory to rationalise the raison d'etre of MLGSs. The basic intuition is that the foundation for MLGSs lies in the inefficiencies created by adverse selection, when borrowers do not have enough collateralisable wealth to satisfy collateral requirements and induce self-selecting contracts. In this setting, we view MLGSs as a wealth-pooling mechanism that allows otherwise inefficiently rationed borrowers to obtain credit. We focus on the case of large, complex urban economies where potential entrepreneurs are numerous and possess no more information about each other than do banks. Despite our extreme assumption on information availability, we show that MLGSs can be characterized by assortative matching in which only safe borrowers have an incentive to join the mutual society.

Keywords: Mutual Loan Guarantee Society, group formation, small business lending, collateral

JEL Classification: D82, G21

Suggested Citation

Busetta, Giovanni and Zazzaro, Alberto, Mutual Loan-Guarantee Societies in Monopolistic Credit Markets with Adverse Selection (June 1, 2009). Available at SSRN: https://ssrn.com/abstract=1498422 or http://dx.doi.org/10.2139/ssrn.1498422

Giovanni Busetta

University of Messina - Department of Economics, Business, Environmental Sciences and Quantitative Methods ( email )

Via T. Cannizzaro 278
Messina, 98122
Italy

Alberto Zazzaro (Contact Author)

Polytechnic University of Marche - Faculty of Economics ( email )

Piazzale Martelli, 8
60121 Ancona
Italy

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