Competition and Strategic Focus in Lending Relationships
34 Pages Posted: 27 Jan 2001
Date Written: October 2000
While competition constrains the ability of banks to extract informational rents from lending relationships, their informational monopoly curtails competition through the threat of adverse selection. These opposing forces also shape banks' incentives to invest in relationship lending expertise. To analyze an intermediary's optimal strategic response to growing competition, we specify a model where the severity of asymmetric information between banks and borrowers increases with informational distance. As increased competition erodes informational rents intermediaries focus more resources on building lending relationships in their core markets. This retrenchment from peripheral loan segments permits banks to fend off the competitive threat to their captive market, even as they continue to offer transactional loans outside their core segment.
Keywords: Banking, competition, relationship lending, specialization, focus
JEL Classification: G21, L1, L14, D4
Suggested Citation: Suggested Citation