"Irresponsible lending" with a better informed lender

The author presents a simple model of personal finance in which an incumbent lender has an information advantage vis-a-vis both potential competitors and households. In order to extract more consumer surplus, a lender with sufficient market power may engage in irresponsible lending, approving credit even if this is knowingly against a household’s best interest. Unless rival lenders are equally well informed, competition may reduce welfare. This holds, in particular, if less informed rivals can free ride on the incumbent’s superior screening ability.