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.
This paper does so in a streamlined model of the banking sector.
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.
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.
To our knowledge, the existing literature does not provide guidance on the merits of such loan restrictions.
Authors thank the editor, two anonymous referees, Jonathan Adams and Eugenio Rojas for very helpful comments and suggestions.
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