Bank Due Diligence in the Business Cycle

Raoul Minetti, Qingqing Cao (), Marco Di Pietro and Sotirios Kokas
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Qingqing Cao: Michigan State University, Department of Economics, Postal: Department of Economics, Michigan State University, 110 Marshall-Adams Hall, 486 W. Circle Dr., East Lansing, MI 48824
Marco Di Pietro: Sapienza University of Rome

No 2020-3, Working Papers from Michigan State University, Department of Economics

Abstract: This paper studies the interaction between bank monitoring and liquidity and its impact on business cycle transmission. We develop a dynamic general equilibrium model with endogenous loan monitoring and constrained banks in retail and wholesale liquidity markets. Liquidity shortages and loan portfolio values govern banks' monitoring incentives and productivity. Calibrating the model to U.S. data reveals that banks monitoring acts as a countercyclical attenuator of aggregate liquidity shocks but as an amplifier of capital shocks that erode loan portfolio values. Credit policies can temporarily dilute stabilizing effects of bank monitoring. The model predictions are broadly consistent with granular evidence on 200 U.S. banks over 1995-2015.

Keywords: Bank monitoring; Liquidity constraints; Business cycles (search for similar items in EconPapers)
JEL-codes: E32 E44 F44 (search for similar items in EconPapers)
Pages: 51 pages
Date: 2020-01-09, Revised 2020-05-11
New Economics Papers: this item is included in nep-ban, nep-dge and nep-mac
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