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RFS Advance Access originally published online on March 26, 2004
Review of Financial Studies 2004 17(4):1073-1102; doi:10.1093/rfs/hhh011
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The Review of Financial Studies Vol. 17, No. 4 © 2004 The Society for Financial Studies; all rights reserved.

Bank Competition and Credit Standards

Martin Ruckes
University of Wisconsin–Madison

Address correspondence to Martin Ruckes, Department of Finance, School of Business, University of Wisconsin–Madison, Madison, WI 53706, or e-mail: ruckes{at}bus.wisc.edu.

This article offers an explanation for the substantial variation of credit standards and price competition among banks over the business cycle. As the economic outlook improves, the average default probabilities of borrowers decline. This affects the profitability of screening and causes bank screening intensity to display an inverse U-shape as a function of economic prospects. Low screening activity in expansions creates intense price competition among lenders and loans are extended to lower-quality borrowers. As the economic outlook worsens, price competition diminishes, and credit standards tighten significantly. Deposit insurance may contribute to the countercyclical variation of credit standards.


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