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Can Competition in the Credit Market be Excessive?

Ramon Caminal () and Carmen Matutes

No 1725, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We study the welfare implications of market power in a model where banks choose between credit rationing and monitoring in order to alleviate an underlying moral-hazard problem. We show that the effect of banks’ market power on social welfare is the result of two countervailing effects. On the one hand, higher market power increases lending rates, worsens the borrower’s incentive problem and investment is further reduced below the efficient level. On the other hand, higher market power induces banks to exert higher monitoring effort and reduces the frequency of credit rationing. Whenever the second effect dominates, it is socially optimal to provide banks with some degree of market power.

Keywords: Credit Rationing; market power; Monitoring; Moral Hazard (search for similar items in EconPapers)
JEL-codes: D82 G21 L10 (search for similar items in EconPapers)
Date: 1997-10
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