The Strategic Use of Market Power in Banking
This paper shows that in protected credit markets banks can overcome their lack of screening ability by offering credit rates unaffordable for borrowers with low creditworthiness. This strategy is optimal only in periods of low expectations of future economic success when expected profit margins are small. As economic expectations improve banks in protected credit markets supply credit also to borrowers with low creditworthiness and the average quality of their lending portfolios deteriorates. We exploit entry barriers erected by state after the approval of the Interstate Banking and Branching Efficiency Act to provide empirical evidence for this strategic use of market power in banking.
Area: Banking
Keywords: Banking Competition Economic expectations
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