Interest Rates and Lending Standards
29 Pages Posted: 11 Jan 2017 Last revised: 18 Jun 2019
Date Written: June 17, 2019
I study the effect of interest rates on banks' lending standards. I find that low (high) interest rates discourage (encourage) screening but facilitate (hinder) effort provision. Less screening, as a result of low interest rates, increases the likelihood of a banking crisis. I further show that (i) when interest rates are endogenous, the demand for loanable funds is non-monotonic and multiple equilibria arise, although higher interest-rate equilibria do not necessarily imply less lending, (ii) entrepreneurial overconfidence has a more profound effect when interest rates are high, and (iii) the effect of market structure on bank risk taking interestingly depends on the level of interest rates.
Keywords: Interest Rates; Lending; Screening; Moral Hazard; Risk Taking; Multiple Equilibria; Overconfidence
JEL Classification: D82; E30; E44; E58; G01; G21
Suggested Citation: Suggested Citation