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Financial Liberalization and Intervention

A New Analysis of Credit Rationing

Santonu Basu

This book seeks to provide a coherent explanation as to why the policies of financial liberalization and financial intervention have been unable to achieve the goal of improving the access of borrowers to the loan market, irrespective of size. This is one of the prime criteria for achieving efficiency in the operation of the loan market and its failure has resulted in increased uncertainty and financial fragility.
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Chapter 7: Concluding Remarks

A New Analysis of Credit Rationing

Santonu Basu


The analysis that has been presented in this book suggests that the loan market operates in the presence of uncertainty and as a result the interest rate alone does not clear it. In this market, the lender will ask for collateral or some form of security, which is referred to as the credit standard, to ensure that should the borrower’s project fail, the borrower has an alternative means to honour his/her debt obligation. Therefore any borrower who is unable to meet a bank’s credit standard requirements will either be denied the loan or will receive less than that demanded. But the puzzling problem is that the banks do not maintain a uniform credit standard for all borrowers. This in turn causes a variation in the borrowers’ access to the loan market. This variation principally arises as the credit standard enters into the loan equation, which suggests that those who will be able to offer collateral of greater value will be able to obtain a larger loan. As the per unit administrative cost for larger loans falls below that for smaller loans with a given interest rate, larger loans will offer higher expected rates of return compared with their smaller counterparts. Large loans are normally demanded by large firms. Large firms, due to their larger size of operation, in general are more likely to enjoy economies of scale of production compared with their smaller counterparts. This means they are more likely to enjoy lower costs per unit of production, given the...

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