Going the Extra Mile: Distant Lending and Credit Cycles

95 Pages Posted: 13 Nov 2018 Last revised: 5 Dec 2020

See all articles by Joao Granja

Joao Granja

University of Chicago - Booth School of Business

Christian Leuz

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); Leibniz Institute SAFE; CESifo Research Network; Center for Financial Studies (CFS)

Raghuram G. Rajan

University of Chicago - Booth School of Business; International Monetary Fund (IMF); National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: December 4, 2020

Abstract

A simple proxy for a bank’s credit risk – the average physical distance of small corporate borrowers from their bank’s branches – suggests risky lending before the global financial crisis was pro-cyclical and especially so in banks operating in counties where banking was competitive. Surprisingly, such lending took off as the Fed raised interest rates between 2004 and 2007. We argue that bank responses to the rate hikes led to a shift of bank deposits into counties where banking was competitive. Short-horizon bank management recycled these new deposits into loans to more distant counties where banking was not competitive. Unfortunately, given the difficulty of making distant small business loans, loan quality deteriorated. We discuss the conditions under which a normalization of interest rates can lead to a deterioration in loan quality.

Keywords: Lending Distance; Credit Cycles; Bank Competition; Bank Risk-Taking; Soft Information

JEL Classification: G20; G21; G28; G32; G34; M48

Suggested Citation

Granja, Joao and Leuz, Christian and Rajan, Raghuram G., Going the Extra Mile: Distant Lending and Credit Cycles (December 4, 2020). Available at SSRN: https://ssrn.com/abstract=3271079 or http://dx.doi.org/10.2139/ssrn.3271079

Joao Granja (Contact Author)

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Christian Leuz

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