Interbank comptetition with costly screening

Xavier Freixas (), Sjaak Hurkens, Alan D. Morrison and Nir Vulkan

Economics Working Papers from Department of Economics and Business, Universitat Pompeu Fabra

Abstract: We analyse credit market equilibrium when banks screen loan applicants. When banks have a convex cost function of screening, a pure strategy equilibrium exists where banks optimally set interest rates at the same level as their competitors. This result complements Broecker’s (1990) analysis, where he demonstrates that no pure strategy equilibrium exists when banks have zero screening costs. In our set up we show that interest rate on loans are largely independent of marginal costs, a feature consistent with the extant empirical evidence. In equilibrium, banks make positive profits in our model in spite of the threat of entry by inactive banks. Moreover, an increase in the number of active banks increases credit risk and so does not improve credit market effciency: this point has important regulatory implications. Finally, we extend our analysis to the case where banks have differing screening abilities.

Keywords: Interbank Competition; Screening; Credit Risk; Adverse Selection (search for similar items in EconPapers)
JEL-codes: D43 D82 G21 G24 (search for similar items in EconPapers)
Date: 2004-11
New Economics Papers: this item is included in nep-fin, nep-fmk and nep-mic
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Related works:
Journal Article: Interbank Competition with Costly Screening (2007)
Working Paper: Interbank Competition with Costly Screening (2005)
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Persistent link: https://EconPapers.repec.org/RePEc:upf:upfgen:802

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