Working Paper: CEPR ID: DP5095
Authors: Giovanni Dell'Ariccia; Robert Marquez
Abstract: This paper examines how the informational structure of loan markets interacts with banks? strategic behaviour in determining lending standards, lending volumes, and the aggregate allocation of credit. In a setting where banks obtain private information about their clients? creditworthiness, we show that banks may loosen lending standards when information asymmetries vis à vis other banks are low. In equilibrium this reduction in standards leads to a deterioration of banks? portfolios, a reduction in their profits, and an aggregate credit expansion. Furthermore, we show that although these low standards may increase aggregate surplus, they also increase the risk of financial instability. We therefore provide an explanation for the sequence of financial liberalization, lending booms, and banking crises that have occurred in many emerging markets.
Keywords: Asymmetric Information; Banking Competition; Lending Standards
JEL Codes: D82; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Low information asymmetries among banks (G21) | Loosen lending standards (G21) |
| Loosen lending standards (G21) | Increase in lending volumes (G21) |
| Loosen lending standards (G21) | Deterioration of banks’ portfolios (F65) |
| Deterioration of banks’ portfolios (F65) | Financing riskier projects indiscriminately (G32) |
| Credit expansion (E51) | Lower and more volatile profits for banks (G21) |
| Lower and more volatile profits for banks (G21) | Increased susceptibility to financial distress during economic downturns (F65) |
| Weaker lending standards (G21) | Banking crises (G01) |