Credit Rationing - Other Contributions - Credit Rationing in Sovereign Lending

Credit Rationing in Sovereign Lending

Finally, it is worthwhile to consider how credit rationing might arise as a feature of sovereign (government) lending, that is, lending to countries. Sovereign lending is a very different story than domestic lending, due to the absence of enforcement mechanisms in the case of bankruptcy, as there is no internationally acknowledged agency for such issues. If a country for one reason or another announces that it is either unable or unwilling to pay its debts, the most international lenders can do is renegotiate. Some experts believe that the threat of the country being shut off from financial markets if it defaults is not credible, as it has to be the case that absolutely no-one is willing to lend. Others stress that though this might be true for the short trem, there are other reputational reasons why a country might want to avoid debt repudiation, mainly pertaining to the maintenance of good foreign relations, which allows access to international trade and technological innovations

With these caveats, it is worthwhile to consider how reputation concerns can lead to credit rationing. The seminal contribution is by Jonathan Eaton and Mark Gersovitz, who consider a simple model of international lending for a small open economy. Lenders set a maximum amount they are willing to lend (credit ceiling), which might be smaller or larger than the borrowing needs of the country. Countries face a penalty if they default, and whenever they are supposed to make debt payments, they consider whether they would be better off by defaulting, paying the penalty, and be forever barred from international credit markets, or pay the debt installment, borrowing again, and making the same decision next period.

As the probability of default is higher when debt is higher, there exists a level of lending that maximises expected return to the lender, and so the credit ceiling will depend on the probability of default. If desired lending is higher than the credit ceiling, some countries will not receive funds, and credit rationing will occur. This setting is reminiscent of Stiglitz and Weiss, as the interest rate has an incentive effect, and does not play the standard allocational role prices are supposed to play. As in that case, the allocation mechanism in Eaton and Gersovitz is credit rationing, which is not related to interest rate (the price of credit); at the going rate, countries want to borrow more but credit is denied.

Read more about this topic:  Credit Rationing, Other Contributions

Famous quotes containing the words lending, sovereign and/or credit:

    And lending it one mental fillip the more, the fact that all these people were inwardly attacked by well-nigh resistless decay, and that most of them were feverish.
    Thomas Mann (1875–1955)

    ‘tis a duteous thing
    To show all honor to an earthly king;
    —Unknown. Yet if His Majesty, Our Sovereign Lord (l. 21–22)

    To give money to a sufferer is only a come-off. It is only a postponement of the real payment, a bribe paid for silence, a credit system in which a paper promise to pay answers for the time instead of liquidation. We owe to man higher succors than food and fire. We owe to man.
    Ralph Waldo Emerson (1803–1882)