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Market Strucutre, Screening Activity and Bank Lending Behavior

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  • Nikolaos Papanikolaou

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    (Luxembourg School of Finance, University of Luxembourg)

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    Abstract

    In this paper we construct a theoretical model of spatial banking competition that considers the differential information among banks and potential borrowers in order to investigate how market structure affects the lending behavior of banks and their incentives to invest in screening technology. Consistent with the prevailing view in the relevant literature, our results reveal that competition reduces lending cost, which, in turn, encourages the entry of new customers in the loan market. Also, that the transportation cost that potential borrowers have to pay in order to reach the bank of their interest is decreased with the degree of competitiveness. Importantly, we demonstrate that market structure exerts a considerable positive effect on banks’ incentives to screen their loan applicants since banks are found to invest more in screening as competition in the market becomes higher. This is to say, banks resort to screening that serves as a buffer mechanism against bad credit which entails higher risk and which is more likely under competitive conditions. Overall, our findings provide support to a rather close link between the degree of competition, bank lending activity, and the investment of banks in screening technology.

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    Bibliographic Info

    Paper provided by Luxembourg School of Finance, University of Luxembourg in its series LSF Research Working Paper Series with number 10-11.

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    Date of creation: 2010
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    Handle: RePEc:crf:wpaper:10-11

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    Keywords: banking; spatial competition; screening; credit risk;

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    1. Christa Hainz & Laurent Weill & Christophe Godlewski, 2013. "Bank Competition and Collateral: Theory and Evidence," Journal of Financial Services Research, Springer, vol. 44(2), pages 131-148, October.
    2. Hyytinen, Ari, 2003. "Information production and lending market competition," Journal of Economics and Business, Elsevier, vol. 55(3), pages 233-253.
    3. Hans Degryse & Steven Ongena, 2002. "Distance, Lending Relationships, and Competition," CSEF Working Papers 80, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
    4. Schnitzer, Monika, 1999. "Enterprise restructuring and bank competition in transition economies," Munich Reprints in Economics 19891, University of Munich, Department of Economics.
    5. Nicola Cetorelli & Pietro F. Peretto, 2000. "Oligopoly banking and capital accumulation," Working Paper Series WP-00-12, Federal Reserve Bank of Chicago.
    6. Mitchell A. Petersen & Raghuram G. Rajan, 2002. "Does Distance Still Matter? The Information Revolution in Small Business Lending," Journal of Finance, American Finance Association, vol. 57(6), pages 2533-2570, December.
    7. Jan Bouckaert & Hans Degryse, 2006. "Entry and Strategic Information Display in Credit Markets," Economic Journal, Royal Economic Society, vol. 116(513), pages 702-720, 07.
    8. Iftekhar Hasan & Anthony Saunders & Viral V. Acharya, 2002. "Should banks be diversified? Evidence from individual bank loan portfolios," BIS Working Papers 118, Bank for International Settlements.
    9. Chiappori, Pierre-Andre & Perez-Castrillo, David & Verdier, Thierry, 1995. "Spatial competition in the banking system: Localization, cross subsidies and the regulation of deposit rates," European Economic Review, Elsevier, vol. 39(5), pages 889-918, May.
    10. John H. Boyd & Gianni De Nicolã, 2005. "The Theory of Bank Risk Taking and Competition Revisited," Journal of Finance, American Finance Association, vol. 60(3), pages 1329-1343, 06.
    11. Steven C. Salop, 1979. "Monopolistic Competition with Outside Goods," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 141-156, Spring.
    12. Robert Hauswald & Robert Marquez, 2006. "Competition and Strategic Information Acquisition in Credit Markets," Review of Financial Studies, Society for Financial Studies, vol. 19(3), pages 967-1000.
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