DP2915 Screening Cycles

Author(s): Thomas Gehrig, Rune Stenbacka
Publication Date: August 2001
Keyword(s): banking competition, financial stability, lending cycles, screening
JEL(s): D83, E32, E44
Programme Areas: Financial Economics, Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=2915

We demonstrate how endogenous information acquisition in credit markets creates lending cycles when competing banks undertake their screening decisions in an uncoordinated way, thereby highlighting the role of intertemporal screening externalities induced by lending market competition as a structural source of instability. We show that uncoordinated screening behaviour of competing banks may be not only the source of an important financial multiplier, but also an independent source of fluctuations inducing business cycles. The screening cycle mechanism is robust to generalizations along many dimensions such as the lending market structure, the lending rate determination and the imperfections in the screening technology.