Welfare effects of limiting bank loans
Journal of Financial Economic Policy
Purpose: 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/approach: This paper does so in a streamlined model of the banking sector. Findings: This 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 implications: The 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/value: To our knowledge, the existing literature does not provide guidance on the merits of such loan restrictions.
Bose, Arup; Pal, Debashis; and Sappington, David, "Welfare effects of limiting bank loans" (2020). Journal Articles. 443.