Attention Allocation and Credit Quality
48 Pages Posted: 15 Mar 2017 Last revised: 18 Jul 2018
Date Written: July 5, 2018
We develop a model of attention allocation to analyse the interaction between credit quality and aggregate economic conditions. Capacity-constrained lenders trade off the number of processed funding applications with the precision of their underwriting process. As the quality of the applicant pool improves, the marginal return to scrutiny decreases. Lenders optimally process more applications but approved loans become riskier ex-ante and generate lower expected returns. The model simultaneously explains the deterioration of credit quality during market booms, tighter standards during recessions, and the counter-cyclical duration of banks’ loan reviews.
Keywords: credit cycle, lending standards, loan officers, attention allocation, capacity constraints, financial accelerators
JEL Classification: G20, G21, E51
Suggested Citation: Suggested Citation