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Collateral Can Help the Bank Distinguish Between Borrowers
Michael Manove, Jorge Padilla, and Marco Pagano’s model illustrates what economists call the screening role of collateral. In their model, collateral helps the bank distinguish between firms that are likely to have positive net present value (NPV) projects and firms that are likely to have negative NPV projects.
Suppose there are two types of firms: firms with high operating costs and firms with low operating costs. When a firm applies for a loan, it knows its operating cost, so it has an idea of whether its project is likely to be successful and have a positive NPV. But since there are other factors affecting the project’s success, the firm cannot know for sure. The bank can find out whether the firm has high costs or low costs as well as other information about the firm’s project, but only after some investigation. Before the bank investigates, all firms look identical to the bank.
To recoup the cost of evaluation the bank must charge some fee. To make sure it puts the appropriate amount of effort into evaluating the loan, the bank charges only those firms whose loans are approved. Otherwise, the bank can make money by charging a fee without doing an evaluation and then rejecting all applicants. In turn, firms whose loans are approved end up subsidizing the firms whose loans are not approved. But since the low-cost firms are the ones whose loans are more likely to be approved, they know they are the ones subsidizing the high-cost firms.
To avoid this, low-cost firms may try to distinguish themselves from high-cost ones by offering to post collateral. An economist would say that the low-cost firm is using collateral to signal its information to the bank. Posting collateral is costly to the firm because the firm loses it if its project fails.
However, since the firm’s costs are low, it knows the project is very likely to succeed and the risk of losing collateral is not large. However, low-cost firms can signal their information using collateral only if high-cost firms find it unprofitable to mimic low-cost firms by posting collateral, too. This is the case if the high- and low-cost firms differ enough. For a high-cost firm, the cost of putting up collateral is much higher than for a low-cost firm because the firm knows it is more likely to default. The result is that low-cost firms post collateral and high-cost firms do not.
The bank can then distinguish between the two firms. If a firm is willing to post collateral, the bank concludes that the firm has low costs and approves the firm’s project without an evaluation; in this case, a careful evaluation is not likely to change the bank’s decision. If a firm is not willing to post collateral, the bank concludes the firm has high costs and evaluates the project; in this case, the bank’s evaluation may indicate that the firm’s project has a positive NPV, even though the firm has high costs.
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发表于 2018-12-15 22:00:16
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