Extreme screening policies

We show that a lender often experiences increasing marginal returns to screening in a standard setting where the lender decides how intensively to screen the projects of prospective borrowers. The increasing marginal returns imply that even small changes in industry parameters can produce large changes in equilibrium screening intensity. In particular, a small reduction in the expected return from borrowers' projects can produce a pronounced increase in the screening of prospective borrowers, with substantial corresponding welfare effects.

► Lenderscreens projects to distinguish between profitable and unprofitable projects. ► Increasing marginal returns to screening accuracy are identified. ► The optimal screening accuracy often will either be very high or very low. ► Small changes in parameters produce large variations in optimal screening accuracy. ► Corresponding welfare effects are pronounced.