| Abstract: |
Most long-term credit in developing countries is allocated throughnegotiated agreements between government institutions and financialintermediaries or final borrowers, and often at administeredrates. Yet many developing countries have no long-term creditmarket whose interest rates can be used as benchmarks for theseloans. If credit is priced improperly, it will be allocatedinefficiently and the development of capital markets may bestunted. In light of the generally disappointing experiencewith conventional methods of allocating development credit,some countries have introduced credit auctions as an alternative.Among the advantages are greater transparency and fairness,lower transaction costs, and increased competition and efficiency.Among the disadvantages are a greater vulnerability to collusion,which can lead to lower interest rates and revenue, and a tendencyto attract the least desirable participants (adverse selection)and to lend for riskier projects (moral hazard), which can leadto lower repayment rates and a higher probability of default.All these factors can lead to inefficiency in the allocationof funds. This article suggests ways to lessen these negativeeffects and presents various elements of auction design thataffect the efficiency of credit auctions and their suitabilityto specific circumstances. When properly designed, auctionscan be used in a variety of environments to allocate developmentcredit more efficiently than current methods do. |
