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Rational Inattention and Counter-Cyclical Lending Standards

42 Pages Posted: 15 Mar 2017 Last revised: 7 Dec 2017

Mike Mariathasan

KU Leuven- Faculty of Economics & Business

Sergey Zhuk

University of Vienna

Date Written: December 1, 2017

Abstract

We develop a model of rational inattention to analyse the interaction between banks' lending standards and aggregate economic conditions. Banks are constrained in their capacity to assess borrower quality and trade off the number of processed loan applications with the precision of their loan review. As aggregate economic conditions improve, the marginal return to additional scrutiny decreases and banks investigate applicants less carefully. As a result, they approve loans that are riskier ex-ante and generate lower expected returns, which can explain excessively lenient lending standards during market booms.

Keywords: credit cycle, lending standards, loan officers, rational inattention, financial accelerators

JEL Classification: G20, G21, E51

Suggested Citation

Mariathasan, Mike and Zhuk, Sergey, Rational Inattention and Counter-Cyclical Lending Standards (December 1, 2017). Available at SSRN: https://ssrn.com/abstract=2933476 or http://dx.doi.org/10.2139/ssrn.2933476

Mike Mariathasan

KU Leuven- Faculty of Economics & Business ( email )

Naamsestraat 69
Leuven, B-3000
Belgium

Sergey Zhuk (Contact Author)

University of Vienna ( email )

Universitätsstrasse 7
Vienna, Vienna 1010
Austria

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