Bank Competition, Information Choice and Inefficient Lending Booms
44 Pages Posted: 19 Dec 2015
Date Written: December 9, 2015
This paper studies the implications of a free-riding problem between competing banks: prospective borrowers can use loan offers of informed lenders to bargain for better terms of credit elsewhere. In anticipation of this problem, banks adopt inefficiently lax lending standards and reduce screening effort in order to deter borrower poaching. In a dynamic version of the model, the distortions from free-riding create inefficient boom-bust cycles in lending: credit is poorly screened and excessive in good times, and is inefficiently rationed during recessions. More bank competition exacerbates the problem and reduces welfare.
Keywords: free-riding, banking competition, poaching, credit booms
JEL Classification: G21, E44, D82
Suggested Citation: Suggested Citation