Lending cycles

We investigate the lending behavior of banks by exploiting a rich panel data set on the contract terms of approximately two million commercial and industrial loans granted by 580 banks between 1977 and 1993. Using a Markov switching panel model we demonstrate that banks change their lending standards — from tightness to laxity — systematically over the cycle. We then use an efficient minimum chi-square estimator to examine the relationship between the cyclical component of aggregate unemployment and bank lending standards when both variables are jointly endogenously determined in a system of simultaneous equations with mixed, continuous/discrete dependent variables. The patterns we uncover suggest that lax-lending standards that tend to occur during expansions exert considerable influence on the dynamics of aggregate fluctiations.