Competition in Credit Markets

Beschreibung

Competition in credit markets is different from competition in simple product markets. The allocation of capital is not only determined by its price, but banks actively decide to whom they will provide finance. In addition, the provision of credit is not a spot transaction, but extends over a certain period of time. Banks need to acquire information in order to efficiently screen borrowers before providing credit and to monitor them during the credit relationship to make sure that the credit will be paid back.

Michael Tröge develops game-theoretic and auction-theoretic models for the strategic interaction of banks in the credit market. He shows that in narrow oligopolies only one bank will carry out detailed creditworthyness tests for a firm and that in very competitive markets information about a borrower´s quality can reduce a bank´s profit. The author also points out that equity ownership of a bank increases the expected interest rates for a firm and that a bank´s concern for a good reputation may lead to credit rationing.

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Since the 1960's, the foundations of finance have either been pure arbitrage or principal agent relationships. This study leaves the Modigliani -Miller world of pure arbitrage -but not the world of equilibria -and turns the principal-agent world upside down. Here the firrns become principals again and banks become agents in the original sense of the word: they act on an auction market. This new view of credit relationships yields a number of interesting insights. In my opinion the most important result is that too close relationships between banks and their borrowers will reduce credit market competition. Michael Tröge thus gives an antitrust reason for the Iimitation of bank involvement in non financial firms. This is not a very relevant issue in the United States where legal responsibility already makes it difficult for banks to inßuence the decisions of the firm. However, in continental Europe, close relationships between banks and firms are widespread and its effects on firrns are subject to a large debate. The author investigates in a first step the impact of the banks' information ahout borrower quality on the competitiveness of the credit market. Precise in formation about the credit quality can yield a competitive advantage for the bank but it does not come without cost. Tröge endogenizes the amount of informa tion acquired in a strategic duopoly and obtains two key results: He first shows that too many banks can lead to excessive spending on information acquisition.
Competition in credit markets is different from competition in simple product markets. The allocation of capital is not only determined by its price, but banks actively decide to whom they will provide finance. In addition, the provision of credit is not a spot transaction, but extends over a certain period of time. Banks need to acquire information in order to efficiently screen borrowers before providing credit and to monitor them during the credit relationship to make sure that the credit will be paid back.

Michael Tröge develops game-theoretic and auction-theoretic models for the strategic interaction of banks in the credit market. He shows that in narrow oligopolies only one bank will carry out detailed creditworthyness tests for a firm and that in very competitive markets information about a borrower´s quality can reduce a bank´s profit. The author also points out that equity ownership of a bank increases the expected interest rates for a firm and that a bank´s concern for a good reputation may lead to credit rationing.

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Michael Tröge

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