Optimal screening capacity and perceived risk of mortgage banks across countries

Abstract In this paper, we investigate the optimal combination of the levels of perceived risk and screening capacity that maximizes the fair value of a mortgage bank, while considering the probability of bank failure and the distribution borrower's wealth across emerging and developed countries. This is a novel contribution to the current literature that does not address that optimal combination and its dependency on the distribution borrower's wealth. We show that in countries where both levels of inequality of borrowers' wealth and the amount of the maximum wealth are high, the bank prefers to adopt a very severe level of perceived risk and cut down the screening capacity to the lowest level that enables the bank to be successful in lending its allotted funds. In countries where the level of wealth inequality decreases, the bank prefers to keep the severe level of perceived risk while increasing its screening capacity. Only when the level of screening capacity is bounded, the bank freezes its level of screening capacity while adopting a medium level of perceived risk.