Liquidity and Discipline. Bank Due Diligence in the Business Cycle

55 Pages Posted: 7 Jul 2020 Last revised: 20 Jan 2021

See all articles by Qingqing Cao

Qingqing Cao

Michigan State University - Department of Economics

Marco Di Pietro

Sapienza University of Rome

Sotirios Kokas

University of Essex - Essex Business School

Raoul Minetti

Michigan State University

Date Written: May 12, 2020

Abstract

The quality of bank lending is increasingly viewed as a force driving the buildup and unfolding of crises. In a dynamic general equilibrium model, we show that banks' access to liquidity and the values of loan portfolios govern banks' incentives and effectiveness in producing information on loans. Consistent with granular loan-level evidence from U.S. banks, the calibrated model predicts that loan due diligence deteriorates during expansions and intensifies during contractions. This countercyclicality attenuates investment and output effects of liquidity shocks but can moderately amplify loan quality shocks. Credit policies may dilute stabilizing e¤ects of due diligence.

Keywords: Banks; Business cycle; Due diligence; Aggregate liquidity

JEL Classification: E32, E44

Suggested Citation

Cao, Qingqing and Di Pietro, Marco and Kokas, Sotirios and Minetti, Raoul, Liquidity and Discipline. Bank Due Diligence in the Business Cycle (May 12, 2020). Available at SSRN: https://ssrn.com/abstract=3598864 or http://dx.doi.org/10.2139/ssrn.3598864

Qingqing Cao

Michigan State University - Department of Economics ( email )

East Lansing, MI 48824
United States

Marco Di Pietro

Sapienza University of Rome ( email )

Piazzale Aldo Moro, 5
Rome, 00185
Italy

HOME PAGE: http://https://sites.google.com/a/uniroma1.it/marcodipietro/

Sotirios Kokas (Contact Author)

University of Essex - Essex Business School ( email )

Wivenhoe Park
Colchester, CO4 3SQ
United Kingdom

Raoul Minetti

Michigan State University ( email )

Agriculture Hall
East Lansing, MI 48824-1122
United States

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