Lending Standards and Borrowing Premia in Unsecured Credit Markets

71 Pages Posted: 9 Jul 2021

See all articles by Kyle Dempsey

Kyle Dempsey

Ohio State University

Anamaria Felicia Ionescu

Board of Governors of the Federal Reserve System

Date Written: June 1, 2021

Abstract

Using administrative data from Y-14M and Equifax, we find evidence for large spreads in excess of those implied by default risk in the U.S. unsecured credit market. These borrowing premia vary widely by borrower risk and imply a nearly flat relationship between loan prices and repayment probabilities, at odds with existing theories. To close this gap, we incorporate supply frictions – a tractably specified form of lending standards – into a model of unsecured credit with aggregate shocks. Our model matches the empirical incidence of both risk and borrowing premia. Both the level and incidence of borrowing premia shape individual and aggregate outcomes. Our baseline model with empirically consistent borrowing premia features 45% less total credit balances and 30% more default than a model with no such premia. In terms of dynamics, we estimate that lending standards were unchanged for low risk borrowers but tightened for high risk borrowers at the outset of Covid-19. Borrowing premia imply a smaller increase in credit usage in response to a negative shock, which this tightening reduced further. Since spreads on loans of all risk levels are countercyclical, all consumers use less unsecured credit for insurance over the cycle, leading to 60% higher relative consumption volatility than in a model with no borrowing premia.

JEL Classification: E21, E32, E44, E51, G12, G21, G22

Suggested Citation

Dempsey, Kyle and Ionescu, Anamaria Felicia, Lending Standards and Borrowing Premia in Unsecured Credit Markets (June 1, 2021). FEDS Working Paper No. 2021-39, Available at SSRN: https://ssrn.com/abstract=3875095 or http://dx.doi.org/10.17016/FEDS.2021.039

Kyle Dempsey (Contact Author)

Ohio State University ( email )

United States

Anamaria Felicia Ionescu

Board of Governors of the Federal Reserve System ( email )

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

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