A Dynamic Theory of Lending Standards
We analyze a dynamic credit market where banks choose lending standards, modeled as costly effort to screen out bad borrowers. Tighter standards worsen the borrower pool, increasing banks’ incentives to employ tight standards in the future. This dynamic complementarity in lending standards can amplify and prolong downturns, decreasing lending and increasing credit spreads. Because lending standards have negative externalities, the market can converge to a steady state with inefficiently tight lending standards. We discuss the role of optimal policy to avoid this outcome as well as the impact of balance sheet costs on lending standards.
Published Versions
Michael J Fishman & Jonathan A Parker & Ludwig Straub & Itay Goldstein, 2024. "A Dynamic Theory of Lending Standards," The Review of Financial Studies, vol 37(8), pages 2355-2402.
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