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Bank Lending with Imperfect Competition and Spillover Effects

  • Sumru G. Altug


  • Murta Usman


We examine bank lending decisions in an economy with spillover effects in the creation of new investment opportunities and asymmetric information in credit markets. We examine pricesetting equilibria with horizontally differentiated banks. If bank lending takes place under a weak corporate governance mechanism and is fraught with agency problems and ineffective bank monitoring, then an equilibrium emerges in which loan supply is strategically restricted. In this equilibrium, the loan restriction, the “under-lending?strategy, provides an advantage to one bank by increasing its market share and sustaining monopoly interest rates. The bank’s incentives for doing so increase under conditions of increased volatility of lending capacities of banks, more severe borrower-side moral hazard, and lower returns on the investment projects. Although this equilibrium is not always unique, with poor bank monitoring and corporate governance, a more intense banking competition renders the bad equilibrium the unique outcome.

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Paper provided by Centre for Dynamic Macroeconomic Analysis in its series CDMA Working Paper Series with number 200608.

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Date of creation: 15 Jul 2006
Date of revision:
Handle: RePEc:san:cdmawp:0608
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