Informational rents in interbank Competition

The present paper develops a two-period, simple model of inter- bank competition based on the idea that banks can partially control the behaviour of borrowers. The control effort by one bank over its customers is not observable by competitor banks. It is shown that the equilibrium behaviour of banks is characterised by a distorted incentive to exert the control effort. A second implication of the model is that unexpected tightening of the interest rate policy by the Central Bank increases the banks' liabilities and thereby influences their loan policy. It is also shown that the returns from control are lower if banks expect that the economy be hit by a negative shock.