Do bad borrowers hurt good borrowers? A model of biased banking competition

David Peón () and Manel Antelo
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David Peón: University of Coruna

Portuguese Economic Journal, 2019, vol. 18, issue 1, No 2, 5-17

Abstract: Abstract This paper explores a two-bank model in which, first, one bank correctly estimates the probability of low-quality loan repayment while the other overestimates it, and second, both banks have identical convex costs when granting loans. In this context of optimistically biased banking competition, we show how the unbiased bank follows the biased competitor as long as the bias of the latter is not too large. This would favour bad borrowers, who get better credit conditions at the expense of good borrowers. As a consequence, the presence of a biased bank increases welfare as long as the expected default rate is sufficiently high. Contrariwise, in subprime markets, biased banking competition would be socially harmful.

Keywords: Overoptimism; Convex costs; Externalities; Crowding-out; Credit financing (search for similar items in EconPapers)
JEL-codes: D62 G02 G21 (search for similar items in EconPapers)
Date: 2019
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DOI: 10.1007/s10258-018-0149-1

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