Liquidity and Discipline. Bank Due Diligence in the Business Cycle
55 Pages Posted: 7 Jul 2020 Last revised: 20 Jan 2021
Date Written: May 12, 2020
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: Suggested Citation