Working Paper: CEPR ID: DP1973
Authors: Thomas Gehrig
Abstract: We analyse competition among banks when banks can use creditworthiness tests that generate (imperfect) information about borrowers. When banks can strategically adjust the test characteristics by investing resources in the screening technology, we show that credit markets are not easily contestable. An increase in the intensity of competition may have little effects on incumbents' conduct and overall market shares. Moreover, we provide conditions under which screening efforts are reduced by competition. In such situations the quality of the overall loan portfolio declines and the economy incurs higher aggregate risk due to the lower quality of banks' information production. The welfare gains from integrating fragmented loan markets can actually be negative.
Keywords: creditworthiness tests; banking competition; imperfect information
JEL Codes: G21; L15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increased competition (L13) | Reduced screening efforts (I14) |
| Reduced screening efforts (I14) | Decline in the quality of the loan portfolio (G33) |
| Decline in the quality of the loan portfolio (G33) | Increase in systemic risk (F65) |
| Increased competition (L13) | Higher risk premium charged to borrowers (G21) |
| Entry of foreign banks (F65) | No significant alteration in behavior of incumbent banks (G28) |
| Incumbents maintain high screening intensity (J78) | Foreign entrants face adverse selection (D82) |