International Bank Lending to LDCs - an Information-Based Approach

This paper presents a theoretical model of international bank lending that may explain "herd-like" behaviour in lending to LDCs. The model assumes that there is a central money-centre bank whose behaviour influences that of regional banks by virtue of the fact that the regional bank can observe the money-centre's lending before making a decision itself. Given this leader-follower relationship and the fact that neither bank has complete information about the borrower, the regional bank's lending behaviour will be influenced by the observed level of lending by the money-centre bank (since it infers some of the money-centre bank's banks information from this). However, since the money-centre bank knows that the regional bank is doing this it can manipulate the regional bank's behaviour by its own actions. Solving this model shows that lending is higher than is optimal (i.e. above what would occur under perfect information). Also, since the borrower realises that lending will be higher and related largely to the strategic interaction between two types of lender he need make less adjustment effort than under perfect information. This paper also presents some informed evidence that this herd-like behaviour, excessive lending and insufficient adjustment occurred between 1979 and 1981 in LDC lending.