Presenter: Jonathan A. Parker
Affiliation: MIT, Sloan School of Management
Paper: A Dynamic Theory of Lending Standards
Date: April 12, 2022
Time: 13:00 GMT
Abstract: We develop a dynamic model of credit markets in which lending standards and the quality of potential borrowers interact. Banks privately choose lending standards: whether to pay to screen out unprofitable borrowers. Lending standards have negative externalities and are dynamic strategic complements: tighter screening worsens the borrower pool, increasing banks’ incentives to screen in the future. Lending standards amplify and prolong temporary downturns, affecting lending volume, credit spreads, and default rates. We characterize constrained-optimal policy, and find it is generally implementable as a government loan insurance program. Finally, capital constraints on banks incentivize tight lending standards, leading to amplification.
Coauthors: Michael Fishman (Northwestern University) and Ludwig Straub (Harvard University).