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A Dynamic Theory of Lending Standards

Author

Listed:
  • 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.

Suggested Citation

  • Michael J Fishman & Jonathan A Parker & Ludwig Straub, 2024. "A Dynamic Theory of Lending Standards," The Review of Financial Studies, Society for Financial Studies, vol. 37(8), pages 2355-2402.
    • Handle: RePEc:oup:rfinst:v:37:y:2024:i:8:p:2355-2402.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhae010
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    More about this item

    Keywords

    D82; G21; G01; G10;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G01 - Financial Economics - - General - - - Financial Crises
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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