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A Dynamic Theory of Lending Standards

Author

Listed:
  • Michael Fishman

    (Northwestern University)

  • Jonathan Parker

    (MIT)

  • Ludwig Straub

    (Harvard)

Abstract

We develop a dynamic model of credit markets in which both lending standards and the quality composition of the borrower pool are endogenous. Borrowers can be of high or low quality, and each lender privately decides on its lending standard. Lending standards are dynamic strategic complements: tighter screening worsens the future pool of borrowers, increasing the incentive to screen in the future. The market exhibits two steady states, one with loose and one with tight lending standards. Lending standards can inefficiently amplify and propagate temporary deteriorations in fundamentals. We discuss policies that improve on market outcomes, and pitfalls to avoid.

Suggested Citation

  • Michael Fishman & Jonathan Parker & Ludwig Straub, 2019. "A Dynamic Theory of Lending Standards," 2019 Meeting Papers 1344, Society for Economic Dynamics.
    • Handle: RePEc:red:sed019:1344
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    References listed on IDEAS

    as
    1. V. V. Chari & Ali Shourideh & Ariel Zetlin-Jones, 2014. "Reputation and Persistence of Adverse Selection in Secondary Loan Markets," American Economic Review, American Economic Association, vol. 104(12), pages 4027-4070, December.
    2. Peter DeMarzo & Darrell Duffie, 1999. "A Liquidity-Based Model of Security Design," Econometrica, Econometric Society, vol. 67(1), pages 65-100, January.
    3. Brendan Daley & Brett Green, 2016. "An Information-Based Theory of Time-Varying Liquidity," Journal of Finance, American Finance Association, vol. 71(2), pages 809-870, April.
    4. Gorton, Gary & Pennacchi, George, 1990. "Financial Intermediaries and Liquidity Creation," Journal of Finance, American Finance Association, vol. 45(1), pages 49-71, March.
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    Cited by:

    1. Ricci, Lorenzo & Soggia, Giovanni & Trimarchi, Lorenzo, 2023. "The impact of bank lending standards on credit to firms," Journal of Banking & Finance, Elsevier, vol. 152(C).
    2. Toni Ahnert & Martin Kuncl, 2019. "Loan Insurance, Market Liquidity, and Lending Standards," Staff Working Papers 19-47, Bank of Canada.
    3. Hu, Yunzhi, 2022. "A dynamic theory of bank lending, firm entry, and investment fluctuations," Journal of Economic Theory, Elsevier, vol. 204(C).
    4. Robert E. Hall & Marianna Kudlyak, 2022. "Why Has the US Economy Recovered So Consistently from Every Recession in the Past 70 Years?," NBER Macroeconomics Annual, University of Chicago Press, vol. 36(1), pages 1-55.
    5. Hachem, Kinda, 2021. "Inefficiently low screening with Walrasian markets," Journal of Monetary Economics, Elsevier, vol. 117(C), pages 935-948.
    6. Ahnert, Toni & Kuncl, Martin, 2022. "Government loan guarantees, market liquidity, and lending standards," Working Paper Series 2710, European Central Bank.
    7. Farboodi, Maryam & Kondor, Péter, 2023. "Cleansing by tight credit: Rational cycles and endogenous lending standards," Journal of Financial Economics, Elsevier, vol. 150(1), pages 46-67.
    8. Ewa Wróbel, 2022. "What drives bank lending policy? The evidence from bank lending survey for Poland," NBP Working Papers 352, Narodowy Bank Polski.
    9. Maryam Farboodi & Péter Kondor, 2020. "Rational Sentiments and Economic Cycles," NBER Working Papers 27472, National Bureau of Economic Research, Inc.

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    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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