Redistribution, Collateral Subsidy and Screening

Under adverse selection, redlining of borrowers may occur when their wealth is not sufficient to reach the collateral needed by creditors to separate types. In this paper, potential entrepreneurs can join in a peer group and voluntarily decide to collect and redistribute their endowments. If the fund is not enough to give everyone the amount of collateral that allows for a separation of types, this paper suggests that the government should intervene with a subsidy on the collateral. This policy produces a unique separating equilibrium and is the optimal intervention in the setup analyzed.