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Micro-Prudential Regulation and Loan Monitoring

Author

Listed:
  • Norvald Instefjord

    (University of Essex)

  • Hiroyuki Nakata

    (University of Tokyo Research Institute of Economy)

Abstract

We evaluate the value of loan monitoring systems for a bank controlled by a micro-prudential regulator. We investigate dynamic systems (an information channel that generates information flow about quality) and static systems (where the lender receives a single signal about loan quality). We find that dynamic systems carry a regulatory charge that dominates the benefit of the systems and are therefore unprofitable, whereas static systems have positive value. Specifically, lenders can profitably dismantle their dynamic systems and instead turn to static monitoring systems. The model reveals, therefore, a potential weakness of micro-prudential regulation.

Suggested Citation

  • Norvald Instefjord & Hiroyuki Nakata, 2023. "Micro-Prudential Regulation and Loan Monitoring," Journal of Financial Services Research, Springer;Western Finance Association, vol. 63(3), pages 339-362, June.
    • Handle: RePEc:kap:jfsres:v:63:y:2023:i:3:d:10.1007_s10693-021-00376-7
    DOI: 10.1007/s10693-021-00376-7
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    References listed on IDEAS

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    More about this item

    Keywords

    Credit scoring; Dynamic monitoring; Loan risk; Loan sales; Optimal stopping; Static monitoring;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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