Overlending and Macroprudential Tools

44 Pages Posted: 30 Jan 2013 Last revised: 18 Mar 2015

See all articles by Pedro Gete

Pedro Gete

IE Business School; IE University

Natalie Tiernan

Georgetown University; Government of the United States of America - Office of the Comptroller of the Currency (OCC)

Date Written: October 2013

Abstract

This paper is a quantitative study of two frictions that generate banks' underinvestment in screening borrowers and, thus, overlending: 1) Limited liability, and 2) Banks failing to internalize that their credit decisions alter the pool of borrowers faced by other banks. The resulting lax lending standards overexpose banks to negative economic shocks and amplify the effects of economic fluctuations. They generate excessive volatility in credit, banks' capital and output. We study a calibrated model whose predictions concerning the quantity and quality of credit are in line with recent U.S. business cycles. Quantitatively, limited liability is the friction that generates laxer lending standards. It induces 27% excess volatility in output relative to 8% from the other friction. Then we study three policy tools: capital requirements and taxes on banks' lending and borrowings. The three tools encourage banks to screen more and should be state-contingent because the frictions vary with macroeconomic conditions. In quantitative terms, we find that taxes are better tools than capital requirements because they do not reduce credit going to the more productive agents.

Keywords: Macroprudential, Lending Standards, Limited Liability, Capital Requirements, Bank Taxation, Overlending

Suggested Citation

Gete, Pedro and Tiernan, Natalie and Tiernan, Natalie, Overlending and Macroprudential Tools (October 2013). Available at SSRN: https://ssrn.com/abstract=2208718 or http://dx.doi.org/10.2139/ssrn.2208718

Pedro Gete (Contact Author)

IE Business School

Calle Maria de Molina 12, Bajo
Madrid, Madrid 28006
Spain

IE University ( email )

Calle Pedro de Valdivia 21
Madrid, Madrid 28006
Spain

Natalie Tiernan

Georgetown University ( email )

37th and O St. NW
Washington, DC 20057
United States

HOME PAGE: http://www12.georgetown.edu/students/nlt6/

Government of the United States of America - Office of the Comptroller of the Currency (OCC) ( email )

400 7th Street SW
Washington, DC 20219
United States

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