Asymmetric information and a theory of compensating balances |
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Authors: | C.W. Sealey Robert Heinkel |
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Affiliation: | McGill University, Montreal, Que., Canada H3A 2T5;University of British Columbia, Vancouver, B.C., Canada V6T 1Y8 |
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Abstract: | This paper derives an economic justification for the existence of compensating balance requirements using an equilibrium model of asymmetric information. Because bank profitability depends upon the probability distribution of a borrower's future cash requirements, and assuming this distribution is known by the borrower but not by the bank, compensating balance requirements can be used by the bank as a screen to distinguish among borrowers. Compensating balances are shown to exist without invoking assumptions of monopoly banks or non-maximizing behavior, and these balances need not be explained as a method of indirect payment for bank services. |
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