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Interbank Competition with Costly Screening

Oxford Financial Research Centre Working Paper No. 2005-FE-02

25 Pages Posted: 25 Jan 2005  

Xavier Freixas

Universitat Pompeu Fabra; Centre for Economic Policy Research (CEPR); Barcelona Graduate School of Economics (Barcelona GSE)

Sjaak Hurkens

Institute for Economic Analysis-CSIC; Barcelona GSE

Alan D. Morrison

University of Oxford - Said Business School; University of Oxford - Merton College

Nir Vulkan

University of Oxford - Said Business School

Multiple version iconThere are 2 versions of this paper

Date Written: November 2004

Abstract

We analyse credit market equilibrium when banks screen loan applicants. When banks have a convex cost function of screening, a pure strategy equilibrium exists where banks optimally set interest rates at the same level as their competitors. This result complements Broecker's (1990) analysis, where he demonstrates that no pure strategy equilibrium exists when banks have zero screening costs. In our set up we show that interest rate on loans are largely independent of marginal costs, a feature consistent with the extant empirical evidence. In equilibrium, banks make positive profits in our model in spite of the threat of entry by inactive banks. Moreover, an increase in the number of active banks increases credit risk and so does not improve credit market efficiency: this point has important regulatory implications. Finally, we extend our analysis to the case where banks have differing screening abilities.

Keywords: Credit market, screening, banking, entry

JEL Classification: G21, L11

Suggested Citation

Freixas, Xavier and Hurkens, Sjaak and Morrison, Alan D. and Vulkan, Nir, Interbank Competition with Costly Screening (November 2004). Oxford Financial Research Centre Working Paper No. 2005-FE-02. Available at SSRN: https://ssrn.com/abstract=653581 or http://dx.doi.org/10.2139/ssrn.653581

Xavier Freixas

Universitat Pompeu Fabra ( email )

Ramon Trias Fargas 25-27
Barcelona, 08005
Spain
+34 93 542 2726 (Phone)
+34 93 542 1746 (Fax)

HOME PAGE: http://www.econ.upf.es/~freixas

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

HOME PAGE: http://www.econ.upf.es/~freixas/more/personal1.htm

Barcelona Graduate School of Economics (Barcelona GSE) ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

J.P.M. (Sjaak) Hurkens

Institute for Economic Analysis-CSIC

campus UAB
Bellaterra, 08193
Spain

Barcelona GSE ( email )

Barcelona
Spain
(34-93) 5806612 (Phone)
(34-93) 5801452 (Fax)

Alan Morrison (Contact Author)

University of Oxford - Said Business School ( email )

Department of Finance
Park End Street
Oxford OX1 1HP
United Kingdom
+44 18 6527 6343 (Phone)
+44 18 6527 6310 (Fax)

University of Oxford - Merton College

Merton Street
Oxford OX1 4JD
United Kingdom
+44 18 6527 6343 (Phone)

Nir Vulkan

University of Oxford - Said Business School ( email )

Park End Street
Oxford, OX1 1HP
Great Britain
+44 01865 288929, or 288338 (Phone)
+44 01865 288805 (Fax)

HOME PAGE: https://vulkan.worc.ox.ac.uk/

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