Credit Rationing

  • C. A. E. Goodhart
Chapter

Summary

In this chapter, we examine the determinants and extent of credit rationing. The most common form of credit rationing is actually that imposed by the authorities’ own credit controls. This is explored in Section 1. Such controls are common in developed countries, and have also been pervasive in less developed countries, LDCs. They have been introduced both for macro-policy purposes, to reduce credit extension, monetary growth and aggregate expenditures without having to raise interest rates as high as would otherwise have been required, and for micro-policy reasons, to ‘improve’ the allocation of scarce credit. Both justifications are, at best, dubious. Disinterme-diation and adverse structural effects hinder the use of credit controls for macro-policy purposes, while such arguments as can be put forward to suggest that official guidance can result in better credit allocation than the free market seem strained and unlikely to be important enough in reality to justify the practice.

Turning in Section 2 to credit rationing that arises from the internal working of credit markets, we follow Jaffee and Modigliani in distinguishing between ‘disequilibrium’ and ‘equilibrium’ rationing. ‘Disequilibrium’ rationing occurs when lenders are slow to adjust the interest rates that they charge on loans as external conditions change. Two examples of such behaviour are given. First, in those cases when interest rates are administratively set by a cartel or by a prominent market leader, various considerations, some ‘political’, will slow the speed of adjustment to equilibrium. This can be quantitatively highly significant, as in the case of UK building societies. Second, in many markets, lenders (market makers) set limits on their exposure to counter-parties. A common reaction to information on the changing credit-worthiness of such counter-parties, at least initially, is to change such limits rather than the rate charged.

Finally, in Section 3, we explore the possibility of the existence of ‘equilibrium’ rationing — i.e., rationing that would still occur after full adjustment to a static equilibrium. Although the actual empirical extent of such rationing is unclear, it has been the subject of greater theoretical interest. Because of the increasing risk of default as interest rates and loan size increase, a bank’s offer curve for loans will tend to be backward bending. Faced with such a curve, borrowers will choose their best available option, which will often involve them in borrowing a lesser sum than they would want at that interest rate in an unconstrained condition. Whether that should or should not be described as ‘rationing’ is a semantic question. When bankers cannot distinguish between borrowers with more or less risky positions, they may then be forced to ration borrowers in circumstances when, with fuller information, both they and the prospective borrower would have preferred to arrange a larger loan at the same interest rates. We end by enquiring whether such information asymmetries can be relaxed or eliminated by varying the collateral requirements, as well as the interest rates, negotiated in the loan agreement. This latter issue seems, as yet, to be undecided.

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© C. A. E Goodhart 1989

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