Loan Insurance, Market Liquidity, and Lending Standards

58 Pages Posted: 3 Mar 2020 Last revised: 16 Aug 2020

See all articles by Toni Ahnert

Toni Ahnert

Government of Canada - Bank of Canada; Centre for Economic Policy Research (CEPR); Systemic Risk Centre - LSE

Martin Kuncl

Government of Canada - Bank of Canada

Date Written: March 2020

Abstract

We examine loan insurance--credit risk transfer upon origination--in a model in which lenders can screen, learn loan quality over time, and can sell loans. Some lenders with low screening ability insure, benefiting from higher market liquidity of insured loans while forgoing the option to exploit future information about loan quality. Insurance also improves the quality of uninsured loans traded but lowers lending standards. We derive testable implications about loan insurance. Since lenders do not internalize its benefit for market liquidity, loan insurance is insufficient and should be subsidized. Our results can inform the design of government-sponsored mortgage guarantees.

Keywords: Adverse Selection, liquidity, Loan insurance, Risk transfer, screening

JEL Classification: G01, G21, G28

Suggested Citation

Ahnert, Toni and Kuncl, Martin, Loan Insurance, Market Liquidity, and Lending Standards (March 2020). CEPR Discussion Paper No. DP14458, Available at SSRN: https://ssrn.com/abstract=3547391

Toni Ahnert (Contact Author)

Government of Canada - Bank of Canada ( email )

234 Wellington Street
Ottawa, Ontario K1A 0G9
Canada
+1 613 782 8765 (Phone)

HOME PAGE: http://toniahnert.com

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Systemic Risk Centre - LSE ( email )

London
United Kingdom

Martin Kuncl

Government of Canada - Bank of Canada ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

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