Consumer Lending When Lenders are More Sophisticated than Households

48 Pages Posted: 23 Mar 2006  

Roman Inderst

Goethe University Frankfurt

Date Written: January 2006

Abstract

We present a simple model of household (or consumer) lending in which, building on past information and local expertise, an incumbent lender has an information advantage both vis-a-vis potential competitors and households. We show that if the adverse selection problem faced by other lenders is sufficiently severe, the incumbent preserves his monopoly power and may engage in too aggressive lending. The incumbent lender may then approve credit even against a household's best interest. In contrast, with effective competition it may now be less informed lenders who lend too aggressively to households who were rejected by the incumbent, though this only occurs if households 'naively' ignore the information contained in their previous rejection. We find that competition may also distort lending as less informed lenders try to free ride on the incumbent's superior screening ability.

Keywords: Consumer and personal finance, irresponsible lending practices, predatory lending

JEL Classification: G1

Suggested Citation

Inderst, Roman, Consumer Lending When Lenders are More Sophisticated than Households (January 2006). CEPR Discussion Paper No. 5410. Available at SSRN: https://ssrn.com/abstract=893069

Roman Inderst (Contact Author)

Goethe University Frankfurt ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt am Main, Hessen 60629
Germany
+49 (69) 798-34601 (Phone)
+49 (69) 798-35000 (Fax)

HOME PAGE: http://www.wiwi.uni-frankfurt.de/en/departments/finance/lehrstuhl/prof-dr-roman-inderst/team

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