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Welfare effects of limiting bank loans

Arup Bose (Indian Statistical Institute, Kolkata, India)
Debashis Pal (University of Cincinnati, Cincinnati, Ohio, USA)
David Sappington (University of Florida, Gainesville, Florida, USA)

Journal of Financial Economic Policy

ISSN: 1757-6385

Article publication date: 19 March 2021

Issue publication date: 28 June 2021

59

Abstract

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.

Keywords

Acknowledgements

Authors thank the editor, two anonymous referees, Jonathan Adams and Eugenio Rojas for very helpful comments and suggestions.

Citation

Bose, A., Pal, D. and Sappington, D. (2021), "Welfare effects of limiting bank loans", Journal of Financial Economic Policy, Vol. 13 No. 4, pp. 442-461. https://doi.org/10.1108/JFEP-06-2020-0122

Publisher

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Emerald Publishing Limited

Copyright © 2020, Emerald Publishing Limited

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