Banking concentration and loan market power in the presence of private information

Speaker: Prof Mei Dong

Affiliation: The University of Melbourne

Location:  Room S402, Social Sciences Building (#24), UQ St Lucia Campus.

Abstract

Conventional wisdom such as the Cournot model suggests a positive relationship between market concentration and market power. In the banking sector, there is a mix of empirical evidence concerning this relationship. We develop a model of banking to investigate how banking concentration affects loan market power measured by the loan rate markup. Banks provide external finance to firms in a decentralized loan market. In the baseline model, search frictions in the loan market makes firms rely more on internal finance when the banking sector is more concentrated, which leads to a lower loan rate. This demand channel produces a negative relationship between banking concentration and loan market power. We then consider private information where firms are privately informed about their own productivity. We find that banks need to screen firms by offering a menu of loan contract. The ability of a firm to obtain external finance will depend on productivity dispersion, banking concentration, and monetary policy. Specifically, when the productivity dispersion is large, a more concentrated banking sector still reduces the need for external finance, but screening requires banks to offer a higher loan rate to high productivity firms and low productivity firms do not borrow. Therefore, the relationship between banking concentration and loan market power depends on the frictions in the loan market. Our model’s predictions about the effects of banking concentration and monetary policy pass-through on loan rate and loan rate dispersion are consistent with existing empirical evidence.

About the presenter's meeting

If you would like to meet with Prof Dong, contact Prof Begoña Dominguez