Endogenous Barriers to Entry into Credit Markets
40 Pages Posted: 1 Dec 2003 Last revised: 23 Jan 2018
Date Written: July 1, 2004
Economic theory suggests that asymmetric information between incumbents and entrants can generate endogenous barriers to entry into credit markets. First, the entrants are more exposed to adverse selection than the incumbents because the pool of agents that apply for a loan to a newcomer contains all those not creditworthy would-be borrowers who were previously rejected by mature banks in the market. Second, incumbents' creditworthiness tests are likely to be more accurate than those run by the entrants because a substantial amount of the information used to screen loan applicants is generated through repeated interaction with the local business community. For both reasons entrants are likely to experience higher loan default rates than the incumbents. We test these theoretical predictions using a unique database of 7,275 observations on 729 individual banks' lending in 95 Italian local markets. We find that both adverse selection and informational disadvantage play a significant role in explaining entrants' loan default rates. We argue that these endogenous barriers can help to explain why entry in many local credit markets by domestic and foreign banks was slow, even after substantial deregulation.
Keywords: credit markets, barriers to entry, winner's curse, asymmetric information
JEL Classification: D82, G21, L13
Suggested Citation: Suggested Citation