Banks, Non Banks, and Lending Standards

Abstract

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 sufficiently high, but do not cause a deterioration in lending standards. Optimal capital requirements trade-off inefficient lending to bad projects under loose standards with inefficient collateral liquidation under tight standards.

Risk-Taking and Monetary Policy Transmission: Evidence from Loans to Smes and Large Firms

“…Very small private firms who lack collateral cannot access credit as they are screened out of the market as inDarst, Refayet, and Vardoulakis (2020). Although we do not observe this extensive margin, as our data is on firms who borrow, our results show that the same intuition works at the intensive margin.…”