Curtailing Bank Loan and Loan Insurance Under Risk Regulations in Supply Chain Finance

Because of many firms' lack of collateral, banks have imposed loan limits as a form of risk-control regulations of bank financing. In response, loan insurance has emerged as a useful instrument to lift loan limits. To study the joint value of bank loans and loan insurance, this article investigates a supply chain composed of one supplier and one capital-constrained buyer who takes out a bank loan and potentially purchases loan insurance. The analysis reveals that both the supplier and the buyer can benefit from the bank financing with loan insurance in an insurance-cooperation region wherein the supplier is willing to reduce the wholesale price to entice the buyer to purchase insurance. Further still, in the insurance-cooperation region, worse contract terms of the bank loan benefit the supplier, whereas worse policy terms of loan insurance help the buyer. Such benefits can lead to a higher order quantity than the capital-abundant one and partially coordinate the entire supply chain. However, when production cost is low, the supplier and the buyer can encounter a Stackelberg prisoner's dilemma, in which both firms no longer cooperate with each other, and both are worse off. Nevertheless, a government subsidy for the insurance premium can not only reduce the Stackelberg prisoner's dilemma, but also improve the social welfare although it is not always optimal for the government to provide that subsidy. The main qualitative results are robust in a variety of extensions.

Automated summary

Due to lack of collateral, banks have set loan limits as a risk-control measure for bank financing. Loan insurance has emerged as a useful tool to lift these limits. This article examines a supply chain consisting of a supplier and a capital-constrained buyer, studying the joint value of bank loans and loan insurance. The findings show that both the supplier and the buyer can benefit from bank financing with loan insurance, leading to higher order quantity and partial coordination of the entire supply chain. However, in cases of low production cost, a prisoner's dilemma can occur, which can be mitigated by government subsidies for insurance premiums to improve social welfare.