Commercial banks frequently encounter optimistic entrepreneurs whose perceptions are biased by wishful thinking. Bankers are left with a difficult screening problem: separating realistic entrepreneurs from optimists who may be clever, knowledgeable, and completely sincere. We build a game-theoretic model of the screening process. We show that although entrepreneurs may practice self-restraint to signal realism, competition may lead banks to be insufficiently conservative in their lending, thus reducing capital-market efficiency. High collateral requirements decrease efficiency further. We discuss bank regulation and bankruptcy rules in connection with the problems that optimistic entrepreneurs present. 1.

Abstract: This study examines the relation of bank loan terms like interest rates, collateral, and lines of credit to borrower risk defined by the banks ’ internal credit rating. The analysis is not restricted to a static view. It also incorporates rating transition and its implications on the relation. Money illusion and phenomena linked with relationship banking are discovered as important factors. The results show that riskier borrowers pay higher loan rate premiums and rely more on bank finance. Housebanks obtain more collateral and provide more finance. Caused by money illusion in times of high market interest rates loan rate premiums are relatively small whereas in times of low market interest rates they are relatively high. There was no evidence for an appropriate adjustment of loan terms to rating changes. But bank market power represented by a weighted average of credit rating before and after a rating transition serves to compensate for low earlier profits caused by phenomena of interest rate smoothing.

We examine the impact of asset liquidation value on debt contracting using a unique set of commercial property loan contracts. We employ commercial zoning regulation to capture the flexibility of a property’s permitted uses as a measure of an asset’s redeployability or value in its next best use. Within a census tract, more redeployable assets receive larger loans with longer maturities and durations, lower interest rates, and fewer creditors, controlling for the property’s type, sale price, and earnings-to-price ratio. These results are consistent with incomplete contracting and transaction cost theories of liquidation value and financial structure.

David Yermack, Greg Udell, and especially the anonymous referee for useful discussions and comments. We also would like to thank Amar Gande and Jayanthi Sunder for help in collecting and organizing the data, and Edward Altman for several helpful discussions on the ratings process.

counterparty risk,

Collateral constraints imply that financing and risk management are fundamentally linked. The opportunity cost of engaging in risk management and conserving debt capacity to hedge future financing needs is forgone current investment, and is higher for more productive and less well-capitalized firms. More constrained firms engage in less risk management and may exhaust their debt capacity and abstain from risk management, consistent with empirical evidence and in contrast to received theory. When cash flows are low, such firms may be unable to seize investment opportunities and instead be forced to downsize; consequently capital may be less productively deployed in downturns. Financing and risk management are fundamentally linked as both involve promises to pay which are limited by collateral constraints. Engaging in risk management and conserving debt capacity have an opportunity cost – current investment is forgone. This cost is higher for more constrained firms. This insight has important implications for the extent of corporate

A fundamental link in the theory of property rights and economic development is that strengthening property rights encourages lenders to use land as collateral and thereby reduces credit rationing and wealth inequalities in financial markets. A nation-wide urban property titling program in Peru, the largest formalization program targeted to urban squatters in the developing world, provides a dramatic natural experiment for testing whether strengthening institutions governing property rights increases the collateral value of landholdings and reduces credit rationing in developing countries. This paper conducts an evaluation of early program impact on credit access. Because the quasi-random program implementation in large measure breaks the link between title acquisition and credit demand, we are able to construct plausible comparison groups in program and non-program regions to estimate the average treatment effect of receiving a title on loan approval rates and interest rates. Detailed data collected on loans from different financial institutions also enables us to compare the impact of title acquisition among banks with alternative lending strategies. We find that land titling is associated with a 9-10 percentage point increase in loan approval rates from the public sector bank for housing construction materials, while there appears to be no effect on the loan approval rate of private sector lenders, indicating a limited improvement in credit rationing in the early stages of the program. However, conditional on receiving a loan, formal sector interest rates are an average of 9 percentage points lower, suggesting an overall reduction in financial market inequalities for the urban poor.

Abstract. We propose a model of discrimination in the market for mortgages. The model explains accepted loan applications and determines loan sizes and interest rates simultaneously. A competitive, and a discriminating monopoly version of the model are proposed. O®ered interest rates and loan sizes are a function of observable borrower characteristics. The competitive model rests on a marginal condition, re°ecting contract optimality, to which a zero-pro¯t condition is added. In contrast, the discriminating monopoly maximizes pro¯ts under a borrower participation constraint, re°ecting the availability of a rental market as an outside option. Each version of the model is a bivariate, nonlinear model, and is estimated by standard maximum likelihood methods. The data used for estimation is a sample of clients of a French network of mortgage lenders. We show the presence of "social discrimination " in the data, the loan conditions depending, not only on the borrower's wage and downpayment, but also on the borrower's occupational status. Abnormally high risk premia in the competitive version of the model suggest the presence of market power, justifying an attempt at estimating its monopolistic version. The discriminating monopoly

This paper considers a simple dynamic model of tax compliance in which people may face binding borrowing constraints. The model leads to much different conclusions and policy recommendations than static models. In particular, the government cannot generate full compliance by setting the expected value of cheating to be negative. Also, it is possible for the government to set penalties in a way that will increase tax revenue over that of full compliance. The government can increase welfare by playing the role of ‘loan shark ’ to people whose borrowing is constrained on the private market. 1.

Abstract: In this study the firms ’ choice of the number of bank relationships is analyzed with respect to influential factors like borrower quality, size and the existence of a close housebank relationship. Then, the number of bank relationships is used as a proxy to examine if bank competition is reflected in loan terms. It is shown that the number of bank relationships is foremost determined by borrower size and the existence of a housebank relationship. Loan rate spreads are not effected by the number of bank relationships. However, borrowers with a small number of bank relationships provide more collateral and get more credit. These effects are amplified by a housebank relationship. Housebanks get more collateral and are ready to take a larger stake in the financing of their customers.