Joint liability among bank borrowers∗

A common feature of financial intermediaries is that the welfare of one borrower is adversely affected by the poor performance of other borrowers. That is, there exists a degree of joint liability among the borrowers of a financial intermediary. This paper provides an explanation for this observation. It demonstrates that in Krasa and Villamil’s [14] formalization of a financial intermediary as a delegated monitor, intermediation with joint liability between borrowers Pareto dominates intermediation without joint liability. ∗I am particularly indebted to Douglas Diamond and Robert Townsend for their advice on this paper. I thank an anonymous referee for helpful comments. Any remaining errors are of course my own. †Northwestern University, Kellogg School of Management, Department of Finance, 2001 Sheridan Road, Evanston IL 60208-2001. Email: [email protected].