Working Paper: CEPR ID: DP2915
Authors: Thomas Gehrig; Rune Stenbacka
Abstract: We demonstrate how endogenous information acquisition in credit markets creates lending cycles when competing banks undertake their screening decisions in an uncoordinated way, thereby highlighting the role of intertemporal screening externalities induced by lending market competition as a structural source of instability. We show that uncoordinated screening behaviour of competing banks may be not only the source of an important financial multiplier, but also an independent source of fluctuations inducing business cycles. The screening cycle mechanism is robust to generalizations along many dimensions such as the lending market structure, the lending rate determination and the imperfections in the screening technology.
Keywords: banking; competition; financial stability; lending cycles; screening
JEL Codes: D83; E32; E44
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| uncoordinated screening behavior (I12) | worsening of the applicant pool (I24) |
| worsening of the applicant pool (I24) | reduces the quality of projects being funded (H43) |
| uncoordinated screening behavior (I12) | reduces the quality of projects being funded (H43) |
| intense competition (L13) | periods of inactivity in lending (G21) |
| screening cycles (C22) | fluctuations in lending and business cycles (E32) |