Reference

Régis Breton (Banque de France and CNRS), “A smoke screen theory of financial intermediation”, Fédération des Banques Françaises Seminar, TSE, September 10, 2012, 12:30–14:00, room MF 323.

Abstract

This paper explores the role of diversification and size in protecting information. We present a simple two period credit market with a sophisticated lender faced with competitors who free ride on his screening activity. Absent commitment problems, the lender funds one borrower and exerts optimal evaluation. When borrowers cannot commit to a long term relationship, the free riding problem is responsible for too little evaluation. We show how this problem can be mitigated by simultaneously financing several borrowers. This effect provides a rationale for intermediaries as an ‘information garbling’ device.

Keywords

financial intermediation; informational rent; asymmetric information; free riding; diversification;

JEL codes

  • D82: Asymmetric and Private Information • Mechanism Design
  • G00: General
  • G21: Banks • Depository Institutions • Micro Finance Institutions • Mortgages

Research partnership

Fédération des Banques Françaises Research Initiative (sustainable)