Bank Lending with Imperfect Competition and Spillover Effects

Sumru Altug () and Murat Usman ()

CDMA Working Paper Series from Centre for Dynamic Macroeconomic Analysis

Abstract: We examine bank lending decisions in an economy with spillover effects in the creation of new investment opportunities and asymmetric information in credit markets. We examine pricesetting equilibria with horizontally differentiated banks. If bank lending takes place under a weak corporate governance mechanism and is fraught with agency problems and ineffective bank monitoring, then an equilibrium emerges in which loan supply is strategically restricted. In this equilibrium, the loan restriction, the “under-lending” strategy, provides an advantage to one bank by increasing its market share and sustaining monopoly interest rates. The bank’s incentives for doing so increase under conditions of increased volatility of lending capacities of banks, more severe borrower-side moral hazard, and lower returns on the investment projects. Although this equilibrium is not always unique, with poor bank monitoring and corporate governance, a more intense banking competition renders the bad equilibrium the unique outcome.

Keywords: Bank lending; threshold effects; underlending equilibria; interest rate competition. (search for similar items in EconPapers)
JEL-codes: E22 E62 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-com, nep-fin, nep-fmk, nep-mac and nep-mic
Date: 2006-07

Published in B.E. Journals in Macroeconomics, Topics in Macroeconomics, 6(1).

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Journal Article: Bank Lending with Imperfect Competition and Spillover Effects (2006)
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Persistent link: http://EconPapers.repec.org/RePEc:san:cdmawp:0608

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