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Bank Due Diligence in the Business Cycle

Author

Listed:
  • Minetti, Raoul

    (Michigan State University, Department of Economics)

  • Cao, Qingqing

    (Michigan State University, Department of Economics)

  • Di Pietro, Marco

    (Sapienza University of Rome)

  • Kokas, Sotirios

    (University of Glasgow)

Abstract

This paper studies the interaction between bank monitoring and liquidity and its impact on business cycle transmission. We develop a dynamic general equilibrium model with endogenous loan monitoring and constrained banks in retail and wholesale liquidity markets. Liquidity shortages and loan portfolio values govern banks' monitoring incentives and productivity. Calibrating the model to U.S. data reveals that banks monitoring acts as a countercyclical attenuator of aggregate liquidity shocks but as an amplifier of capital shocks that erode loan portfolio values. Credit policies can temporarily dilute stabilizing effects of bank monitoring. The model predictions are broadly consistent with granular evidence on 200 U.S. banks over 1995-2015.

Suggested Citation

  • Minetti, Raoul & Cao, Qingqing & Di Pietro, Marco & Kokas, Sotirios, 2020. "Bank Due Diligence in the Business Cycle," Working Papers 2020-3, Michigan State University, Department of Economics, revised 11 May 2020.
    • Handle: RePEc:ris:msuecw:2020_003
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    References listed on IDEAS

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    More about this item

    Keywords

    Bank monitoring; Liquidity constraints; Business cycles;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles

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