Revisiting Lerner: market power in a value-based framework

This paper derives the Lerner Index within a dynamic, value-based framework in which a bank’s ability to extract rents depends not only on the price elasticities of loan and deposit demand, but also on the persistence of customer relationships. In this framework, persistence acts as a structural determinant of market power through two countervailing effects. By enlarging loan and deposit volumes, persistence lowers measured demand elasticities and increases market power. However, because pricing affects future retained volumes, persistence also increases intertemporal demand sensitivity and can reduce market power. Because persistence links market power to bank stability and efficiency, its explicit inclusion in theoretical and empirical market power models may reconcile divergent findings in the stability and efficiency literatures. Regarding stability, persistence strengthens risk-reduction incentives by increasing franchise value and rents placed at risk, but also prolongs exposure to destabilizing credit shocks. Additionally, persistence links market power to bank efficiency by influencing the balance between short-term and long-term cost control.