Using behavioral economics to analyze credit policies in the banking industry

Abstract

2008 world financial meltdown highlighted significant shortcomings on procedures used by the banking sector to provide credit to the real economy. A long period of indulgence granting personal loans and mortgages that boosted a credit bubble all over the world has been followed by an era of suspicion within the banking sector, precipitating the liquidity crunch and the credit squeeze to private agents. Behavioral Finance has emerged as an alternative approach to analyze efficiency on financial markets, revealing a world with less than fully rational investors and arbitrageurs limited by risk aversion, short time horizons and agency problems. In this paper we consider the possibility to extend Behavioral Finance topics such as investor sentiment, overconfidence, heuristics or herd instinct to analyze banks behavior when providing credit to private agents, and how the absence of arbitrageurs in the credit market could justify the role of public banking as a countercyclical policy maker.