Volume 43, Number 171,
October-December 2012
Credit Rationing:
A Perspective from New Keynesian Economics
Abigail Rodríguez and Francisco Venegas
FINANCING AND EVALUATING INVESTMENT PROJECTS

While the first interpretations of credit rationing were centered on the ideas of supply and credit price rigidity, research on this topic soon began to incorporate analyses of the characteristics of credit demand and imperfect information. Most of the interest was oriented towards situations in which the demand for resources is justified to finance investment projects, and credit is consequently granted in accordance with an evaluation of these projects.

Pioneering works from Freimer and Gordon (1965), Jaffee and Modigliani (1969) and De Meza and Webb (1992) stand out in this field. When information is incomplete but symmetrical, credit is rationed as a function of the expected results of the projects to be financed. Jaffee and Russell (1976) analyze the problem of “moral risk” for borrowers. Facing an asymmetry of information, they may select which project to execute, given that they understand the probability distribution of their yields. Stiglitz and Weiss (1981), Allen (1983) and Bester (1985) write that asymmetry of information leads to the problem of “adverse selection,” where the lenders grant credit to the most risky applicants, in an attempt to maximize earnings. Williamson (1987) analyzes the “monitoring costs” incurred by the entity granting the resources to ensure that they are returned. Bernanke and Gertler (1989) analyze the “agency costs,” resulting from the borrower’s inability to monitor its clients. This section briefly presents the specifics of these models.

Freimer and Gordon (1965) assume that productive investment is only possible if all resources are contributed by commercial banks. The credit supply is a function of the active interest rate, the size of the loan and the investment opportunities. These authors believe that the greater the expected result of the project and the greater the difference between the active rate charged to the borrower and the rate it costs the bank to use these resources, the more credit is granted.

Jaffee and Modigliani’s (1969) proposal seeks to generalize Freimer and Gordon’s (1965) work through the following assumptions: the size of the investment project is fixed, the expected results of investment are independent of the size of credit and the companies have alternative financing sources besides banking credit. Their results indicate that the supply of loans has the same “backwards” behavior indicated by Hodgman (1960), but there is a segment of the curve where any amount of credit is granted at an expected yield rate. This occurs when the expected yield rate R is equal to the rate for the cost of resources for bank I5. They also observe that when banks can differentiate their clients, they apply price discrimination and establish a different active rate in accordance with risk. In this case, rationing credit is not optimal. However, if price discrimination is not feasible and all clients must be charged the same active interest rate, rationing credit becomes optimal. Rationing does not apply for clients with no risk of default.

Meza and Webb (1992) demonstrate that rationing is possible with symmetrical information even if this information is incomplete because the agents do not know if a favorable or unfavorable economic situation will prevail. They attribute the cause to competition between banks, which leads to lower interest rates being demanded at levels below the optimal rate, and brings about an increase in credit demand and rationing.

Jaffee and Russell (1976) emphasize the importance of uncertainty and asymmetry of information when granting loans. They propose that rationing is the result of adverse selection. Jaffee and Russell assume that there are “honest” individuals, who only accept credit that they know they can pay and do not default even when they have incentives to do so, and “dishonest” individuals, who apply for credit with the intention to default if the penalty is minimal. The bank cannot differentiate between these types of clients because the features of their applications for resources are similar. A default also might not have to do with individual motivation. The clients may be “fortunate” or “unfortunate.” Assuming that future income is a random variable, unfortunate individuals may have income below what was expected and may be forced to default.

5 In terms of Figure 1, Jaffee and Modigliani’s (1969) results indicate that the credit supply curve Cr5s should initially be represented with a horizontal segment, for some positive rate r (ordered from the positive origin).

Published in Mexico, 2012-2017 © D.R. Universidad Nacional Autónoma de México (UNAM).
PROBLEMAS DEL DESARROLLO. REVISTA LATINOAMERICANA DE ECONOMÍA, Volume 49, Number 192, January-March is a quarterly publication by the Universidad Nacional Autónoma de México, Ciudad Universitaria, Coyoacán, CP 04510, México, D.F. by Instituto de Investigaciones Económicas, Circuito Mario de la Cueva, Ciudad Universitaria, Coyoacán,
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