Competing for Loan Seniority : Implications and Evidence

Abstract

Borrowing from multiple lenders can lead to a debt dilution problem: Lenders do not internalize that issuing a new loan can affect borrowers’ ability and incentive to pay off loans provided by other lenders. Using data on the universe of retail loans in Brazil, we provide new causal estimates of the debt dilution channel. We show that, when unable to repay all their credit card debt, defaulters prioritize repaying the balance on their cards with the highest credit limit; cards originated by fintech companies, or cards from lenders that also sold them other financial products. Motivated by these facts, we develop a new structural model of lending with non-exclusive contracts in which lenders can use contract terms to gain loan seniority. We use the model to analyze and quantify the impact of debt dilution on contract terms and welfare.