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Banks, Non Banks, and Lending Standards
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 ...
Explaining the Boom-Bust Cycle in the U.S. Housing Market: A Reverse-Engineering Approach
We use a simple quantitative asset pricing model to ?reverse-engineer? the sequences of stochastic shocks to housing demand and lending standards that are needed to exactly replicate the boom-bust patterns in U.S. household real estate value and mortgage debt over the period 1995 to 2012. Conditional on the observed paths for U.S. disposable income growth and the mortgage interest rate, we consider four different specifications of the model that vary according to the way that household expectations are formed (rational versus moving average forecast rules) and the maturity of the mortgage ...
Consumer risk appetite, the credit cycle, and the housing bubble
We explore the role of consumer risk appetite in the initiation of credit cycles and as an early trigger of the U.S. mortgage crisis. We analyze a panel data set of mortgages originated between the years 2000 and 2009 and follow their performance up to 2014. After controlling for all the usual observable effects, we show that a strong residual vintage effect remains. This vintage effect correlates well with consumer mortgage demand, as measured by the Federal Reserve Board?s Senior Loan Officer Opinion Survey, and correlates well to changes in mortgage pricing at the time the loan was ...
Bank Capital, Loan Liquidity, and Credit Standards since the Global Financial Crisis
Did the 2007-09 financial crisis or the regulatory reforms that followed alter how banks change their underwriting standards over the course of the business cycle? We provide some simple, “narrative” evidence on that question by studying the reasons banks cite when they report a change in commercial credit standards in the Federal Reserve’s Senior Loan Officer Opinion Survey. We find that the economic outlook, risk tolerance, and other real factors generally drive standards more than financial factors such as bank capital and loan market liquidity. Those financial factors have mattered ...
Bank Market Power and the Risk Channel of Monetary Policy
This paper investigates the risk channel of monetary policy through banks' lending standards. We modify the classic costly state verification (CSV) problem by introducing a risk-neutral monopolistic bank, which maximizes profits subject to borrower participation. While the bank can diversify idiosyncratic default risk, it bears the aggregate risk. We show that, in partial equilibrium, the bank prefers a higher leverage ratio of borrowers, when the profitability of lending increases, e.g. after a monetary expansion. This risk channel persists when we embed our contract in a standard New ...