'Irresponsible Lending' with a Better Informed Lender

Abstract

We present a simple model of personal finance in which an incumbent lender has an information advantage both vis-a-vis potential competitors and households. We show how in order to extract more consumer surplus an incumbent with sufficient market power may optimally engage in irresponsible lending, approving credit even against a household's own best interest. To extract more surplus, the incumbent may even make a (cash) advance above the value of the purchased good. We also show that increased competition that does not level out the information asymmetry between the incumbent lenders and its competitors may not always increase welfare, in particular if less informed lenders can free ride on the incumbent's superior screening ability.

Keywords: Consumer and personal finance, irresponsible lending practices, predatory lending

JEL Classification: G1, G2