Do Loan Commitments Cause Overlending?

51 Pages Posted: 17 Sep 2003

See all articles by Anjan V. Thakor

Anjan V. Thakor

Washington University in St. Louis - John M. Olin Business School; Financial Theory Group; European Corporate Governance Institute (ECGI); Massachusetts Institute of Technology (MIT) - Laboratory for Financial Engineering

Date Written: September 2003

Abstract

I begin with a model that generates quantity credit rationing by banks in the spot credit market when the real interest rate is high and there is an economic downturn. Then I rationalize a bank loan commitment as partial insurance against such future rationing. Incorporating uncertainty about both the creditworthiness of borrowers and the abilities of banks to screen borrowers, I extend the bank contracting literature wherein I examine banks' decisions of whether to lend under the commitments sold earlier. I show that this discretion of whether to honor borrowing requests under commitments generates reputational concerns on the part of banks and can lead to an equilibrium in which loan commitments serve their role in increasing credit supply relative to the spot credit market, but produce the inefficiency of excessive credit supply when the real interest rate is low and the economy is doing well. Despite this, welfare is higher with loan commitments than with spot credit. Numerous empirical predictions and policy implications are drawn out.

Keywords: Loan Commitments, Overlending

Suggested Citation

Thakor, Anjan V., Do Loan Commitments Cause Overlending? (September 2003). Available at SSRN: https://ssrn.com/abstract=444720 or http://dx.doi.org/10.2139/ssrn.444720

Anjan V. Thakor (Contact Author)

Washington University in St. Louis - John M. Olin Business School ( email )

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Campus Box 1133
St. Louis, MO 63130-4899
United States

Financial Theory Group ( email )

United States

European Corporate Governance Institute (ECGI) ( email )

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Belgium

Massachusetts Institute of Technology (MIT) - Laboratory for Financial Engineering ( email )

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Cambridge, MA 02142
United States

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