We analyse the impact of market structure on the probability of banking failure when banks’ loan portfolios are subject to aggregate uncertainty. In our model borrowers are subject to a moral hazard problem, which induces banks to choose between two second-best alternative devices: costly monitoring and credit rationing. We show that investment depends on both the lending rate and the information structure. Since monitoring incentives increase with interest rate margins, the relationship between market structure and investment is ambiguous. Also, larger investment levels imply that the expected return of marginal projects is lower and thus banks’ portfolios are more vulnerable to aggregate uncertainty. Consequently, a monopoly bank monitors borrowers more intensively, rations the amount of credit less frequently and hence may go bankrupt with higher probability than competitive banks.
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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number
1665.
Find related papers by JEL classification: D4 - Microeconomics - - Market Structure and Pricing D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages
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