Bank Lending and Interest Rate Changes in a Dynamic Matching ModelWP/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. |