Working Paper: NBER ID: w27610
Authors: Michael J. Fishman; Jonathan A. Parker; Ludwig Straub
Abstract: We analyze a dynamic credit market where banks choose lending standards, modeled as costly effort to screen out bad borrowers. Tighter standards worsen the borrower pool, increasing banks’ incentives to employ tight standards in the future. This dynamic complementarity in lending standards can amplify and prolong downturns, decreasing lending and increasing credit spreads. Because lending standards have negative externalities, the market can converge to a steady state with inefficiently tight lending standards. We discuss the role of optimal policy to avoid this outcome as well as the impact of balance sheet costs on lending standards.
Keywords: lending standards; credit markets; government intervention; borrower quality; dynamic model
JEL Codes: D82; E51; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| tighter lending standards (G21) | worse quality of borrower pool (G21) |
| worse quality of borrower pool (G21) | tighter lending standards in the future (G21) |
| tighter lending standards (G21) | self-reinforcing cycle of tighter standards (E32) |
| inefficiently tight lending standards (G21) | negative externalities for the credit market (E44) |
| government intervention (O25) | relax lending standards (G21) |
| slow thawing (Y50) | reduced lending volumes (G21) |
| reduced lending volumes (G21) | prolonged recovery periods (C41) |