Large crises tend to follow rapid credit expansions. Causality, however, is far from obvious. We show how this pattern arises naturally when financial intermediaries optimally exploit economic rents that drive their franchise value. As this franchise value fluctuates over the business cycle, so too do the incentives to engage in risky lending. The model leads to novel insights on the effects of unconventional monetary policies in developed economies. We argue that bank lending might have responded less than expected to these interventions because they enhanced franchise value, inadvertently encouraging banks to pursue safer investments in low-risk government securities.
We are grateful for comments by Jules van Binsbergen, Bernard Dumas, Vadim Elenev, Andrea Ferraro, Nicola Gennaioli, François Gourio, Skander Van den Heuvel, Martin Oehmke, Adi Sunderam, Urszula Szczerbowicz, Yao Zeng, and seminar participants at Bocconi, USC, Wharton, The Federal Reserve Board, and the CAPR, American Finance Association, FIRS, Adam Smith, German Bundesbank/ECB Systemic Risk, IDC Herzliya, RCFS/RAPS, and UNC-Duke conferences. All errors remain our own. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
João F. Gomes & Marco Grotteria & Jessica A. Wachter, 2023. "Foreseen Risks," Journal of Economic Theory, .