Attention Allocation and Counter-Cyclical Credit Quality
42 Pages Posted: 15 Mar 2017 Last revised: 23 Nov 2018
Date Written: November 6, 2018
We develop a model of capacity-constrained lenders, who trade off the depth of their loan review with the number of funding applications they process. We find that better economic conditions cause the marginal return to scrutiny to decrease. Lenders therefore process more applications, but approve riskier loans that – paradoxically – generate lower expected returns. Our model rationalises the endogenous deterioration of credit quality during market booms, tighter lending standards during recessions, and counter-cyclical loan underwriting times.
Keywords: credit cycle, lending standards, loan officers, attention allocation, capacity constraints, financial accelerators
JEL Classification: G20, G21, E51
Suggested Citation: Suggested Citation