Screening, Lending Intensity, and the Aggregate Response to a Bank Tax

Kinda Hachem

No 469, 2011 Meeting Papers from Society for Economic Dynamics

Abstract: Understanding how banks allocate their resources across different intermediation activities is crucial for gauging the health of the credit market. In this paper, I show that banks do not fully internalize the effects of their allocation decisions, leading to an inefficiently high amount of low-quality credit. I begin by constructing a model that captures two key features of the financial system. First, competition among lenders means that banks must use resources to attract clients and create credit matches. Second, asymmetric information means that resources also need to be devoted to screening once a client has been attracted. After analyzing how individual banks choose to allocate limited resources across these activities, I establish the existence of a unique steady state and calibrate the model to U.S. data. I find that optimal decisions impart externalities on both the beliefs and the outside options of other lenders, with the direction of these inefficiencies motivating a tax on the matching activity. Steady state results suggest that production exhibits a hump-shaped response to increases in this tax and the model's dynamics indicate that a mild tax can also attenuate business cycle fluctuations.

Date: 2011
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed011:469

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