What Determines Banks' Market Power? Akerlof or Herfindahl

Abstract

We introduce a theoretical model predicting that banks' interest rate markups follow a lifecycle pattern. Due to endogenous bank monitoring by competing banks, borrowing firms initially face a low markup, thereafter an increasing markup until it falls for old firms. By applying a large sample of small firms and a new measure of asymmetric information, we find that firms with significant asymmetric information problems have a more pronounced life-cycle pattern of interest rate markups. We also examine effects of concentrated banking markets on interest markups. Results indicate that markups are mainly driven by asymmetric information problems (Akerlof). However,we find weak evidence that bank market concentration is important for old firms (Herfindahl).

Keywords: Banking, loan-pricing, lock-in, asymmetric information, competition

JEL Classification: G21, L15