Market structure, screening activity and the lending behaviour of banks

In this paper, we use a spatial model of industrial organization that considers the differential information among banks and potential borrowers to investigate how competition affects the lending behavior of banks and their incentives to invest in screening technology. Our analysis suggests that by lowering its lending rate a bank can extend its market share by ‘poaching ’ customers from the rival banks that turn out to be relatively more expensive. Moreover, that enhanced competition has a negative effect on the demand for loans of individual banks. Consistent with the prevailing view, our results further show that a larger number of banks reduces lending cost, which, in turn, encourages the entry of new customers in the loan market. Also, that market structure has an important impact on banks ’ incentives to screen loan applicants. In particular, we find that banks invest more in screening as a result of higher competition. This is largely explained by the fact that banks are more easily mistaken in their lending decisions when the number of credit applicants increases due to intensified competition. Consequently, banks resort to screening in order to efficiently protect themselves against excessive credit risk. Overall, our results provide support to a rather close relationship between the industry structure, the lending activity of banks, and bank investment in screening technology