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RFS Advance Access published online on March 26, 2004
Review of Financial Studies, doi:10.1093/rfs/hhh011
Review of Financial Studies © The Society for Financial Studies 2004; all rights reserved
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The Review of Financial Studies © The Society for Financial Studies 2004; all rights reserved.

Original Articles

Bank Competition and Credit Standards

Martin Ruckes 1*
1 University of Wisconsin-Madison, School of Business, Department of Finance, Madison, WI 53706, USA

* To whom correspondence should be addressed. E-mail: ruckes{at}bus.wisc.edu.


  Abstract

This paper 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 affecs 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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