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Welfare effects of limiting bank loans

Welfare effects of limiting bank loans 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/approachThis paper does so in a streamlined model of the banking sector.FindingsThis 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 implicationsThe 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/valueTo our knowledge, the existing literature does not provide guidance on the merits of such loan restrictions. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Financial Economic Policy Emerald Publishing

Welfare effects of limiting bank loans

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Publisher
Emerald Publishing
Copyright
© Emerald Publishing Limited
ISSN
1757-6385
DOI
10.1108/jfep-06-2020-0122
Publisher site
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Abstract

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/approachThis paper does so in a streamlined model of the banking sector.FindingsThis 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 implicationsThe 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/valueTo our knowledge, the existing literature does not provide guidance on the merits of such loan restrictions.

Journal

Journal of Financial Economic Policy – Emerald Publishing

Published: Jun 28, 2021

Keywords: Banks; Microeconomics; Regulation and industrial policy; Lending restrictions; Welfare; Loan portfolio quality; JEL Code G2; L5

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