A Dynamic Theory of Bank Lending, Firm Entry, and Investment Fluctuations

50 Pages Posted: 12 Sep 2017 Last revised: 20 Apr 2018

See all articles by Yunzhi Hu

Yunzhi Hu

University of North Carolina (UNC) at Chapel Hill - Finance Area

Date Written: August 11, 2017

Abstract

This paper offers a dynamic theory of bank lending standards with two features. First, bank screening takes time. Second, the borrower pool is determined endogenously by firm entry. I show that in booms, banks reduce standards by offering unscreened credit to any borrower, which results in many low-quality firms entering the pool. In busts, high-quality borrowers delay borrowing if the average quality of the pool is sufficiently low. If so, banks increase standards by offering credit only after screening. With that expectation, only high-quality firms enter the pool. The implied investment fluctuations can be related to macroeconomic recoveries.

Keywords: Bank Lending Standards, Dynamic Adverse Selection, Credit Cycle

Suggested Citation

Hu, Yunzhi, A Dynamic Theory of Bank Lending, Firm Entry, and Investment Fluctuations (August 11, 2017). Available at SSRN: https://ssrn.com/abstract=3004956 or http://dx.doi.org/10.2139/ssrn.3004956

Yunzhi Hu (Contact Author)

University of North Carolina (UNC) at Chapel Hill - Finance Area ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
221
Abstract Views
1,023
rank
179,229
PlumX Metrics