Lending Booms and Lending Standards
47 Pages Posted: 5 Aug 2005
There are 2 versions of this paper
Date Written: June 2005
Abstract
This paper examines how the informational structure of loan markets interacts with banks' strategic behavior in determining lending standards, lending volumes, and the aggregate allocation of credit. In a setting where banks obtain private information about their clients' creditworthiness, we show that banks may loosen lending standards when information asymmetries vis a vis other banks are low. In equilibrium this reduction in standards leads to a deterioration of banks' portfolios, a reduction in their profits, and an aggregate credit expansion. Furthermore, we show that although these low standards may increase aggregate surplus, they also increase the risk of financial instability. We, therefore, provide an explanation for the sequence of financial liberalization, lending booms, and banking crises that have occurred in many emerging markets.
Keywords: Banking competition, lending standards, asymmetric information
JEL Classification: D82, G21
Suggested Citation: Suggested Citation
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