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Lending Booms and Lending Standards

Authors

  • GIOVANNI DELL'ARICCIA,

  • ROBERT MARQUEZ

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    • Dell'Ariccia is at the International Monetary Fund (IMF) and the Center for Economic Policy Research (CEPR). Marquez is at Arizona State University. We thank Patrick Bolton, Tito Cordella, José de Gregorio, Gianni De Nicoló, Paolo Fulghieri, Ilan Goldfajn, Pietro Garibaldi, Christa Hainz, George McCandless, Beatrix Paal, Bruno Parigi, Carmen Reinhart, David Webb, and seminar participants at the University of Minnesota, University of North Carolina, University of British Columbia, Wharton School of Business, Columbia University, IMF, Federal Reserve Banks of New York and San Francisco, ECB, 2004 Financial Intermediation Research Society Conference, 2003 European University Institute conference on the “Micro-Structure of Credit Contracts”, 2003 conference on “Competition in Banking Markets” held at Leuven, and First Workshop of the Latin American Finance Network (2003) for useful suggestions. All remaining errors are ours. The views expressed in this paper are those of the authors and do not necessarily represent those of the IMF or CEPR.

ABSTRACT

We examine how the informational structure of loan markets interacts with banks' strategic behavior in determining lending standards, lending volume, and the aggregate allocation of credit. We show that, as banks obtain private information about borrowers and information asymmetries across banks decrease, banks may loosen their lending standards, leading to an equilibrium with deteriorated bank portfolios, lower profits, and expanded aggregate credit. These lower standards are associated with greater aggregate surplus and greater risk of financial instability. We therefore provide an explanation for the sequence of financial liberalization, lending booms, and banking crises observed in many emerging markets.

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