Pre-Crisis Credit Standards: Monetary Policy or the Savings Glut?

39 Pages Posted: 16 Nov 2014

Date Written: November 2014


This paper presents a theoretical model of how banks set their credit standards. It examines how a monopoly bank sets its monitoring intensity in order to manage credit risk when it makes long duration loans to borrowers who have private knowledge of their project's stochastic profitability. In contrast to standard models, it has a recursive structure and a general equilibrium. The bank loan contract considered specifies the interest rate, the monitoring intensity and a profitability covenant. Within this class of contract, the bank chooses the terms which maximise steady-state profits subject to the constraint that it must have as many deposits as loans. The model is then used to consider whether the reduction in credit standards and credit spreads observed before the financial crisis could have been caused by low official interest rates or a positive deposit shock. The model rejects a risk-taking channel of monetary policy and endorses the savings glut hypothesis.

Keywords: credit standards, credit risk, monitoring, risk-taking channel, savings glut

JEL Classification: G21

Suggested Citation

Penalver, Adrian, Pre-Crisis Credit Standards: Monetary Policy or the Savings Glut? (November 2014). Banque de France Working Paper No. 519, Available at SSRN: or

Adrian Penalver (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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