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 price-setting 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.
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Find related papers by JEL classification: C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages O16 - Economic Development, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment
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Shleifer, Andrei & Vishny, Robert W, 1997.
" A Survey of Corporate Governance,"
Journal of Finance,
American Finance Association, vol. 52(2), pages 737-83, June.
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Levitan, Richard & Shubik, Martin, 1972.
"Price Duopoly and Capacity Constraints,"
International Economic Review,
Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 13(1), pages 111-22, February.
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