A Dynamic Theory of Multiple Borrowing

Abstract

Multiple borrowing—a borrower obtains overlapping loans from multiple lenders—is a common phenomenon in many credit markets. We build a highly tractable, dynamic model of multiple borrowing and show that, because overlapping creditors may impose default externalities on each other, expanding financial access by introducing more lenders may severely backfire. Capital allocation is distorted away from the most productive uses. Entrepreneurs choose inefficient endeavors with low returns-to-scale. These problems are exacerbated when investments become more pledgeable or when borrowers have access to more lenders, explaining why increased access to finance does not always improve outcomes.

Keywords: Commitment, Multiple Borrowing, Common Agency, Microfinance, Investment, Misallocation

JEL Classification: C73, D24, E22, G11, G21