Regions with high inequallity suffer credit rationing

Olivier Coibion, Yuriy Gorodnichenko, Marianna Kudlyak, John Mondragon

Income inequality and credit rationing

We present a model that provides one potential supply-side explanation for why differential borrowing behaviours could be related to regional inequality. Each region is composed of two types of households, such that ‘high-type’ households have higher income on average than ‘low-type’ households, and are also less likely to (exogenously) default on debt. Banks in each region lend to these households, but do not observe households’ types – only their income and another signal correlated with the underlying type. The key mechanism in the model is that as local income inequality rises, banks treat an applicant’s income as an increasingly precise signal about their type, and therefore target lending toward higher-income households on average. We show how the latter can be accomplished via differential rejection rates (in monopoly banking settings) or differential interest rates (in competitive banking settings). In both cases, banks will make credit more readily accessible (or cheaper) to high-income households when local inequality is higher, because the latter implies that income is a more precise signal of applicant types.

A segmention effect. Reduce bank transaction by segmenting according to income when a know group of lower income borrers are in the market.