Credit Bureau Policy and Sustainable Reputation Effects in Credit Markets.

Abstract

Welfare-increasing reputation effects arise in credit markets when adverse selection gives rise to borrower reputation formation incentives that mitigate moral hazard problems. This paper shows that welfare stemming from reputation effects will diminish over time as the private information of borrowers is revealed to lenders in the form of lengthening credit histories. Aggregate borrower welfare may, therefore, decrease over time unless reputation effects can be sustained. Restricting a lender's access to a borrower's credit history via credit bureau policy is shown to be one method of sustaining reputation effects and preventing a decline in welfare. Copyright 1995 by The London School of Economics and Political Science.