Abstract

A Dynamic Model of Credit Relations between a Bank and its Borrowers

The object of the article is to show that for lenders it may prove rational in certain situations to prolong credit commitments and/or increase the amounts involved, although the resulting credit positions are more risky than would be consonant with the average security requirements (credit norms) of the bank with respect to its lendings. The additional credit would be impermissible in the view of the bank, i.e., the borrower would not be creditworthy, if credit claims against the borrower in question had not been built up in the previous periods. It may be impermissible in the view of any other bank with the same expectations and the same attitude to risks, if such other bank has not hitherto entered into credit relations with the borrower in question. The possible behaviour of the bank in trying to save dubious credits by granting additional credits, or throwing good money after bad, is demonstrated with the help of a simple, dynamic model of the credit-granting decision process. Simultaneously this model serves to bring out some important determinants of lender-borrower relations, which may favour such behaviour. Over and above this, the model gives occasion to draw attention to instruments which banks can use to avoid in later phases of credit relations situations in which they may be constrained to resort to an ex ante unintended prolongation or increase of their credit.