Financial Collusion and Over-Lending
Working Paper No. 02-W29R
Jinyoung Hwang, Neville Nien-Heui Jiang, and Ping Wang
ABSTRACT [article]
We build a model consisting of a borrowing firm, a lending institution (bank), and a third party influencing loan decision-making (auditor/government regulator) where a low-type firm can bribe the auditor to file an untruthful report about its true type so as to obtain a loan from the bank to finance a risky project. The main finding is that, depending on the economic environment, the bank may or may not want to deter such a collusion. This implies there may be a sudden shift from a collusion to a no-collusion equilibrium as the economic environment deteriorates. The combination of noticeable gradual deterioration in fundamentals and expectations of a sudden equilibrium-shift can trigger aggressive speculative attacks and passive withdrawals of investments even before the actual equilibrium-shift takes
place. We apply this hypothesis to the case of the 1997 Korean financial crisis that features a severe over-lending problem.
Keywords and Phrases: Collusion, financial crisis, dishonest auditors, over-lending
JEL Classification Numbers: D82, G30, O16