Banks, Non banks, and Lending Standards

51 Pages Posted: 10 Nov 2020

See all articles by Matthew Darst

Matthew Darst

Board of Governors of the Federal Reserve System

Ehraz Refayet

Office of the Comptroller of the Currency, Department of Treasury

Alexandros Vardoulakis

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: September 21, 2020

Abstract

We study how competition between banks and non-banks affects lending standards. Banks have private information about some borrowers and are subject to capital requirements to mitigate risk-taking incentives from deposit insurance. Non-banks are uninformed and market forces determine their capital structure. We show that lending standards monotonically increase in bank capital requirements. Intuitively, higher capital requirements raise banks' skin in the game and screening out bad projects assures positive expected lending returns. Non-banks enter the market when capital requirements are sufficiently high, but do not cause a deterioration in lending standards. Optimal capital requirements trade-off inefficient lending to bad projects under loose standards with inefficient collateral liquidation under tight standards.

Keywords: lending standards, credit cycles, asymmetric information, non-banks, regulation

JEL Classification: G01, G21, G28

Suggested Citation

Darst, Matthew and Refayet, Ehraz and Vardoulakis, Alexandros, Banks, Non banks, and Lending Standards (September 21, 2020). Available at SSRN: https://ssrn.com/abstract=3696541 or http://dx.doi.org/10.2139/ssrn.3696541

Matthew Darst (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Ehraz Refayet

Office of the Comptroller of the Currency, Department of Treasury ( email )

400 7th Street SW
Washington, DC 20219
United States

HOME PAGE: http://www.occ.treas.gov/topics/economics/economics-staff/bios/ehraz-refayet-bio.html

Alexandros Vardoulakis

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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