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Interbank Competition with Costly Screening

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  • Xavier Freixas
  • Sjaak Hurkens
  • Alan D. Morrison
  • Nir Vulkan

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 efficiency: this point has important regulatory implications. Finally, we extend our analysis to the case where banks have differing screening abilities.

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Bibliographic Info

Paper provided by Oxford Financial Research Centre in its series OFRC Working Papers Series with number 2005fe02.

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Date of creation: 2005
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Handle: RePEc:sbs:wpsefe:2005fe02

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  1. Petersen, Mitchell A & Rajan, Raghuram G, 1995. "The Effect of Credit Market Competition on Lending Relationships," The Quarterly Journal of Economics, MIT Press, vol. 110(2), pages 407-43, May.
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Cited by:
  1. Arnoud W.A. Boot & Matej Marinc, 2006. "Competition and Entry in Banking: Implications for Stability and Capital Regulation," Tinbergen Institute Discussion Papers 06-015/2, Tinbergen Institute.
  2. CARLETTI, Elena & LEONELLO, Agnese, 2012. "Credit Market Competition and Liquidity Crises," Economics Working Papers ECO2012/14, European University Institute.

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