Banking (Conservatively) with Optimists
Volume: Volume 30, No. 2
Issue: Summer 1999
Pages: pp. 324-350
Authors: Michael Manove and A. Jorge Padilla
Title: Banking (Conservatively) with Optimists
Abstract: Commercial banks frequently encounter optimistic entrepreneurs whose perceptions are biased by wishful thinking. Bankers are left with a difficult screening problem: separating realistic entrepreneurs from optimists who may be clever, knowledgeable, and completely sincere. We build a game-theoretic model of the screening process. We show that although entrepreneurs may practice self-restraint to signal realism, competition may lead banks to be insufficiently conservative in their lending, thus reducing capital-market efficiency. High collateral requirements decrease efficiency further. We discuss bank regulation and bankruptcy rules in connection with the problems that optimistic entrepreneurs present.
JEL Classification
Banks Other Depository Institutions Mortgages (G210)
Entrepreneurship New Firms Startups (M130)
Business Credit (3153)
Financial Intermediaries (3140)
Commercial Banking (3120)
Capitalist Economic Systems: Market Economies (0510)