"Adverse Selection and Credit Rationing in a Crisis"
Publication type: Working paper
How costly was it for banks to extend additional credit to households at the onset of the financial crisis? We present empirical evidence on the role of adverse selection and moral hazard in determining the cost of new lending following a discontinuous rise in the cost of capital in the summer of 2007. We use unique data on millions of credit card accounts for a leading commercial bank to analyze the effects of the rise in the cost of capital on new and continuing lending and consumer delinquency. Consistent with credit rationing theories, the rise in interest rates resulting from the increased cost of capital led to a sharp increase in default rates for new borrowers, despite a rise in the relative creditworthiness of new borrowers along observable dimensions. Our results suggest an important role for informational frictions in determining credit availability during the financial crisis.
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