Lending Booms, Smart Bankers and Financial Crises

8 Pages Posted: 1 Apr 2015

See all articles by Anjan V. Thakor

Anjan V. Thakor

Washington University, Saint Louis - John M. Olin School of Business; European Corporate Governance Institute (ECGI)

Date Written: January 19, 2015

Abstract

This paper develops a theory that explains why financial crises follow profitable lending booms. When agents exhibit the "availability heuristic" and there is a long period of banking profitability, all agents — banks, their investors and regulators — end up in an “availability cascade,” overestimating bankers’ risk-management skills and underestimating the probability that observed outcomes are due to good luck. Consequently, banks profitably invest in riskier assets. Subsequently, if a public signal reveals that outcomes are luck-driven, investors withdraw funds, liquidity evaporates, and a crisis ensues. A loan resale market improves liquidity but increases the probability of a crisis.

Keywords: financial crises, availability heuristic, bankers' skills

JEL Classification: D81, E58, G21

Suggested Citation

Thakor, Anjan V., Lending Booms, Smart Bankers and Financial Crises (January 19, 2015). American Economic Review, 2015 Forthcoming. Available at SSRN: https://ssrn.com/abstract=2587168 or http://dx.doi.org/10.2139/ssrn.2587168

Anjan V. Thakor (Contact Author)

Washington University, Saint Louis - John M. Olin School of Business ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

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