Bank Lending and Interest Rate Changes in a Dynamic Matching Model


WP/98/93-EA
WP/98/93



This paper proposes theory and gives evidence on the dynamic relationship
between aggregate bank lending and changes in money market rates.
Theoretically, it proposes a matching model of the market for loans and argues
that lending expansion and contraction are time-consuming activities.
Investment opportunities might be difficult to find, and screening potential
applicants might impose a time constraint on the banking system.s ability to
issue new loans. Similarly, recalling nonperforming loans often requires an
uncertain and time-consuming legal procedure that limits the banks. ability to
rapidly recover their capital. As a result, the speed at which lending
opportunities become available and banks can recall existing loans are
important determinants of the dynamic response of bank lending to changes in
money market rates. In particular, when banks can rapidly recall nonperforming
loans but experience technological delays in expanding credit, the response of
bank lending to interest rate changes is likely to be asymmetric: positive
changes result in the immediate contraction of bank loans, whereas negative
changes produce only a gradual expansion of bank lending. More generally, the
speed of credit contraction and expansion are determined by different
structural and institutional factors, and econometric procedures that impose
aggregate lending to respond symmetrically to interest rate changes are likely
to be overestrictive.

Empirically, the paper investigates whether the response of bank lending to
interest rate changes is indeed asymmetric, as most parameterizations of the
model would suggest. Empirical evidence for Mexico and the United States
confirms the theoretical intuition and suggests that bank lending reacts
asymmetrically to exogenous money market perturbations. In particular, banks
react more rapidly to market interest rate increases in both countries.