Inequality of Opportunity in the Credit Market

This paper focuses on the relationship between equality of opportunity and the credit market. It seeks to find out if the possibility of getting credit is determined by collateral.

Credit market imperfections can prevent the poor from making profitable investments. Under full information, each project is funded only by an evaluation of the borrowers effort. Under conditions of asymmetric information, however, observable features such as wealth and collateral play an important role in determining who gets credit. The study constructs a model that analyzes how a competitive equilibrium performs in terms of equality of opportunity. It demonstrates that:

• Richer individuals are more likely to get credit for a given aversion to effort due to larger cross subsidization in high collateral classes of borrowers;
• Inequality of opportunity is associated with inefficient allocation of resources among various borrower classes;
• Marginal borrower in classes that post more collateral exerts less effort than the marginal borrower in low collateral classes.

Study findings suggest that public credit policies should be targeted at poorer classes of borrowers, for equity as well as efficiency reasons.