Welfare effects of limiting bank loans

Arup Bose, Debashis Pal and David Sappington

Journal of Financial Economic Policy, 2021, vol. 13, issue 4, 442-461

Abstract: Purpose - This paper examines the effects of limiting the number of loans a bank can issue, reflecting a policy recently implemented by the US Federal Reserve. Design/methodology/approach - This paper does so in a streamlined model of the banking sector. Findings - This paper finds that a binding limit on loans can enhance welfare by motivating the bank to reduce the number of socially unproductive loans it makes. However, the limit can sometimes reduce welfare by inducing a reduction in the number of socially productive loans the bank issues, the quality of the bank’s loan portfolio, and/or the accuracy with which the bank screens loan opportunities. Practical implications - The research demonstrates that limits on the loans a bank issues can have subtle and unintended consequences. Consequently, careful thought is warranted before such limits are imposed. Originality/value - To our knowledge, the existing literature does not provide guidance on the merits of such loan restrictions.

Keywords: Banks; Microeconomics; Regulation and industrial policy; Lending restrictions; Welfare; Loan portfolio quality; JEL Code G2; L5 (search for similar items in EconPapers)
Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:eme:jfeppp:jfep-06-2020-0122

DOI: 10.1108/JFEP-06-2020-0122

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