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The suspension of borrowing: an implicit penalty for loan default under imperfect information
Authors:Xinhua Gu  Xiaolin Qian  Haizhen Guo
Institution:Department of Finance and Business Economics, Faculty of Business Administration, University of Macau, Macao, China
Abstract:A credit seeker may be suspended from borrowing for a period of time due to a previous default. Such suspension is widely used in bank lending through credit check. Our work analyses the effects of suspension on the investment choice of borrowers under uncertainty and on the lending policy of banks facing asymmetric information. We show that suspension should be tightened at low loan rates, but loosened otherwise, to improve the repayment performance of borrowers. We also show that although credit rationing may not be completely removed due to imperfect information, the excess demand for credit or transitive waiting in the market can actually be attenuated by such efficient use of suspension. Our theoretical predictions are consistent with observed cyclical patterns of changes in lendingrates and suspension severity.
Keywords:Credit rationing  interest rate  suspension penalty  imperfect information
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