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Can competition in the credit market be excessive?

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Abstract

We study how market power affects investment and welfare when banks choose between restricting loan sizes and monitoring, in order to alleviate an underlying moral hazard problem. The impact of market power on aggregate welfare is the result of two countervailing effects. An increase in banks' market power results in: (i) higher lending rates, which worsens the borrower's incentive problem and reduces investment by unmonitored firms, (ii) higher monitoring effort, which reduces the proportion of credit-constrained firms. Whenever the second effect dominates, it is optimal to provide banks with some degree of market power.

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  • Ramon Caminal & Carmen Matutes, 2002. "Can competition in the credit market be excessive?," UFAE and IAE Working Papers 527.02, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
    • Handle: RePEc:aub:autbar:527.02
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    More about this item

    Keywords

    market power; monitoring; loan size rationing; moral hazard;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • L10 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - General

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