Abstract: We develop a simple model of relationship lending where lenders have an incentive to evergreen loans by offering better terms to less productive and more indebted firms. We detect such lending distortions using loan-level supervisory data for the United States. Low-capitalized banks systematically distort their risk assessments of firms to window-dress their balance sheets and extend relatively more credit to underreported borrowers. Consistent with our theoretical predictions, these effects are driven by larger outstanding loans and low-productivity firms. We incorporate the theoretical mechanism into a dynamic heterogeneous-firm model to show that evergreening can affect aggregate outcomes, resulting in lower interest rates, higher levels of debt, and lower aggregate productivity.
File format is application/pdf
Description: Full Text
Provider: Federal Reserve Bank of St. Louis
Part of Series: Working Papers
Publication Date: 2021-10-22