Credit Markets with Ethical Banks and Motivated Borrowers

Abstract

This paper investigates banks' corporate social responsibility. The credit market is composed of two sectors: one for standard and one for ethical projects. Since ethical banks are committed to investing in ethical projects, standard and ethical banks compete in the market for ethical projects. The latter have also a social profitability, but a lower expected revenue with respect to standard ones. If their expected revenue is not too low, ethical projects are undertaken by motivated borrowers. The latter obtain a benefit (a social responsibility premium) from accomplishing ethical projects in general and a premium for successful interaction when trading with ethical banks in the case the project is successful.If the expected profitability of ethical projects is sufficiently close to that of standard ones and/or the premium for successful interaction of motivated borrowers is sufficiently high, ethical banks are active, both sectors of the credit market exist and the whole market is fully segmented. This result holds true irrespective of the information structure: only moral hazard on the borrower side, moral hazard and screening on the borrower side. The optimal contract in our set-up is always a debt contract. However, its precise form and welfare properties depend on the information structure.Jel classification: D86, G21, G30.

Informed Principals in the Credit Market When Borrowers and Lenders are Heterogeneous

“…The model is borrowed from Tirole (2006) and has been illustrated in Barigozzi and Tedeschi (2015). Here we brie ‡y present the model's setup and refer the reader to the mentioned paper for a detailed discussion of the assumptions about motivated borrowers, ethical banks and ethical projects and for some real world examples.…”

“…Such allocation indicates the menu of incentive compatible contracts that are pro…table type-by-type and allow separation at the lowest cost. 2 Conversely, in our model heterogeneous principals (borrowers) propose contracts to uninformed and heterogeneous agents (lenders). The important di¤erence is that, in our Contract Proposal Game, informed principals o¤er two 2 Maskin and Tirole (1992) name the RSW allocation, where the incentive-compatible contracts are pro…table type-bytype, after the in ‡uential papers by Rothschild and Stiglitz (1976) and Wilson (1977).…”

“…2 Conversely, in our model heterogeneous principals (borrowers) propose contracts to uninformed and heterogeneous agents (lenders). The important di¤erence is that, in our Contract Proposal Game, informed principals o¤er two 2 Maskin and Tirole (1992) name the RSW allocation, where the incentive-compatible contracts are pro…table type-bytype, after the in ‡uential papers by Rothschild and Stiglitz (1976) and Wilson (1977). As we will further discuss in the paper, informed principals can always guarantee themselves the payo¤ reached with the RSW allocation which is the unique equilibrium when it is interim e¢ cient.…”

“…Contrary to ethical banks, motivated borrowers do not commit to ethical projects and will still invest in standard projects if their expected return is su¢ ciently higher than the one of ethical projects. Barigozzi and Tedeschi (2015) show that the assortative matching between ethical banks and motivated borrowers allows to reduce the frictions caused by moral hazard. The e¢ ciency gain can be so high that motivated borrowers trading with ethical banks end up receiving better contract conditions than standard borrowers trading with commercial banks.…”

“…Section 2 describes the model set-up and the payo¤s of socially responsible lenders and motivated borrowers. In Section 3, we show how the matching between socially responsible agents relaxes the incentive compatible constraint of motivated borrowers and we brie ‡y report results from Barigozzi and Tedeschi (2015) about the characterization of loan agreements o¤ered in the credit market under moral-hazard only. Section 4 solves the model with both moral-hazard and adverse selection.…”