This paper analyzes the role of expected income in entrepreneurial borrowing. We claim that poorer individuals are safer borrowers because they value more the relationship with the bank. We study the dynamics of a monopolistic bank granting loans and taking deposits from overlapping generations of entrepreneurs with di¤erent levels of expected income. Matching the evidence of the Grameen Bank we show that a bank will focus on individuals with lower expected income, and will not disburse dividends until it reaches all the potential borrowers.We …nd empirical support for our theoretical results using data from a household survey from Bangladesh. We show that various measures of expected income are positively and signi…cantly correlated with default probabilities.
Abstract:We analyze under what conditions competitive credit markets are efficient in providing loans to entrepreneurs who can start a new project after failure. An entrepreneur of uncertain talent chooses the riskiness of her project. If banks privately observe the entrepreneur's risk choices, two equilibria coexist: (1) an inefficient equilibrium in which the entrepreneur realizes a low-risk project and has no access to finance after failure and (2) a more efficient equilibrium in which the entrepreneur first realizes high-risk projects and then, after continuous failures, a low-risk project. There is a non-monotonic relationship between bank information and potential credit market inefficiency. We discuss the implications for credit registers and entrepreneurial education.
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