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Liquidity and Discipline. Bank due Diligence Over the Business Cycle

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  • Qingqing Cao
  • Marco Di Pietro
  • Sotirios Kokas
  • Raoul Minetti

Abstract

The quality of bank lending is increasingly viewed as a force driving the buildup and unfolding of crises. In a dynamic general equilibrium model, we show that banks’ access to liquidity and the values of loan portfolios govern banks’ incentives and effectiveness in producing information on loans. Consistent with granular loan-level evidence from US banks, the calibrated model predicts that loan due diligence deteriorates during expansions and intensifies during contractions. This countercyclicality attenuates investment and output effects of liquidity shocks but can moderately amplify loan quality shocks. Credit policies may dilute stabilizing effects of due diligence.

Suggested Citation

  • Qingqing Cao & Marco Di Pietro & Sotirios Kokas & Raoul Minetti, 2022. "Liquidity and Discipline. Bank due Diligence Over the Business Cycle," Journal of the European Economic Association, European Economic Association, vol. 20(5), pages 2136-2180.
    • Handle: RePEc:oup:jeurec:v:20:y:2022:i:5:p:2136-2180.
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    File URL: http://hdl.handle.net/10.1093/jeea/jvac022
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    Cited by:

    1. Biswas, Sonny, 2023. "Collateral and bank screening as complements: A spillover effect," Journal of Economic Theory, Elsevier, vol. 212(C).

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