Soft Collateral, Bank Lending, and the Optimal Credit Registry

We study the design of an optimal credit registry in a general equilibrium steady-state setting where borrowers can default strategically and future access to credit markets serves as soft collateral to enforce loan repayment. We endogenize the probabilities for exclusion after default and subsequent reinstatement of clean credit records. When there are sufficient funds, optimal credit stringency is as loose as possible, subject to borrowers’ incentive constraints. When there are insufficient funds, credit stringency is driven by the need to equilibrate nonexcluded borrowers with available funds, and it increases as the imbalance grows. We examine how population growth, mortality, and persistence affect our results. Finally, we compare the simple two-tier scheme with the three-tier scheme and characterize solutions to a general N-tier registry. We show that a more graduated registry is not necessarily a better one.

This paper was accepted by Will Cong, finance.