Bank competition and credit booms

Phurichai Rungcharoenkitkul

No 488, BIS Working Papers from Bank for International Settlements

Abstract: A model of imperfectly competitive banks is examined under asymmetric information about borrower quality. Greater bank competition and a lower risk-free rate raise the screening costs of lending, which can result in pooling Nash equilibria with credit booms. Such equilibria are characterised by sharp increases in credit supply and deteriorations in average loan quality, which are inefficient for banks. In the model, banks' incentives to make risky loans can vary despite unchanged capital structure, thus highlighting the role of a risk-taking mechanism. This approach helps explain the existing mixed empirical results on the relationship between bank competition and financial stability. The model can be used to define a neutral interest rate in the context of financial cycles, namely a finance-neutral interest rate, which is estimated in the case of the United States.

Keywords: bank competition; credit booms; asymmetric information; optimal contract; coordination failure; finance-neutral rate of interest; monetary policy (search for similar items in EconPapers)
Pages: 40 pages
Date: 2015-02
New Economics Papers: this item is included in nep-ban and nep-com
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Citations: View citations in EconPapers (5)

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