Bank Loan Markups and Adverse Selection

52 Pages Posted: 1 Dec 2020 Last revised: 9 Jun 2022

See all articles by Mehdi Beyhaghi

Mehdi Beyhaghi

Federal Reserve Banks - Federal Reserve Bank of Richmond

Cesare Fracassi

University of Texas at Austin; Coinbase Institute

Gregory Weitzner

McGill University

Date Written: June 2022

Abstract

We analyze market power in local US corporate loan markets. To identify market power, we create a measure of markup that incorporates banks’ internal loan-level risk assessments and is orthogonal to the subsequent performance of loans. In contrast to typical theories of competition, we find that markups are higher in regions in which more banks operate. We provide evidence that this result is driven by asymmetric information across banks, which becomes exacerbated as the number of banks increase. We also provide causal support for the adverse selection channel by showing that markups drop following a shock to large banks’ lending capacities that reduces asymmetric information in local lending markets. Our findings suggest that adverse selection is an important driver of market power in local bank markets and have implications for antitrust policy.

Keywords: bank loans, adverse selection, market power

JEL Classification: G21, G28, L13, L44, G32

Suggested Citation

Beyhaghi, Mehdi and Fracassi, Cesare and Weitzner, Gregory, Bank Loan Markups and Adverse Selection (June 2022). Available at SSRN: https://ssrn.com/abstract=3733932 or http://dx.doi.org/10.2139/ssrn.3733932

Mehdi Beyhaghi

Federal Reserve Banks - Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

Cesare Fracassi

University of Texas at Austin ( email )

McCombs School of Business
2110 Speedway Stop B6600
Austin, TX 78712-1276
United States
512-232-6843 (Phone)

HOME PAGE: http://https://faculty.mccombs.utexas.edu/cesare.fracassi/

Coinbase Institute ( email )

Gregory Weitzner (Contact Author)

McGill University ( email )

1001 Sherbrooke St. W
Montreal, Quebec H3A 1G5
Canada

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