Extractive bribe and default in subsidized credit programs

We present a dynamic model of subsidized credit provision to examine how asymmetric information exacerbates inefficiency caused by corruption. If a borrower and a corrupt official interact with symmetric information, credit terms can be so designed that corruption will affect only the borrower’s profit, but not repayment. With private information on the borrower’s productivity this result changes. Because of dynamic information rents, the official may induce one type of the borrower to default. The government can improve the repayment rate, but will have to under-provide credit. In contrast, some allowance of default permits a greater supply of credit.