Modeling operational risk for good and bad bank loans

Parnes, Dror

doi:10.21314/jop.2012.116

Cited by 3 publications

(2 citation statements)

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“…Alternate conclusions can emerge under different conditions even when the bank is omniscient. To illustrate, suppose bad loans (which reduce welfare) are unprofitable for the bank (so p B < 0), perhaps, because the business venture financed by a bad loan fails and the borrower does not repay the loan (Parnes, 2012). When good loans are profitable and bad loans are unprofitable, an omniscient bank will only issue good loans (which increase social welfare).…”

Section: A Benchmark Settingmentioning

confidence: 99%

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Welfare effects of limiting bank loans

Bose

Pal

Sappington

2021

JFEP

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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.

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Section: A Benchmark Settingmentioning

confidence: 99%

“…9. In settings where p B < 0, the bank can be viewed as making a Type I error (pursuing an unprofitable loan opportunity) with probability 1-b and a Type II error (failing to pursue a profitable loan opportunity) with probability 1-g (Parnes, 2012).…”

Section: Limits On Loansmentioning

confidence: 99%