Information Reusability, Competition and Bank Asset Quality

The paper explains the recent decline in bank asset quality using the notion of information reusability. Banks are viewed as information processors; they exist because of their advantage in extracting the surplus associated with the reusability of borrower-specific information. It is shown that a bank's incentive to screen loan applicants, and hence maintain the quality of its assets, depends on the surplus this screening can produce, which in turn depends on information reusability. Two recent changes in banks' operating environment are increased competition and greater temporal volatility in borrower credit risks. The former has directly reduced banks' informational surplus while the latter has impaired information reusability. Hence screening expenditures have been reduced and the diminution of screening has lowered the quality of bank assets. It is also shown that an increase in deposit insurance premia has an effect similar to that of narrowing interest spreads and therefore will result in reduced asset screening and impaired asset quality.