DP1973 Screening, Cross-Border Banking and the Allocation of Credit
We analyse competition among banks when banks can use creditworthiness tests that generate (imperfect) information about borrowers. When banks can strategically adjust the test characteristics by investing resources in the screening technology, we show that credit markets are not easily contestable. An increase in the intensity of competition may have little effects on incumbents' conduct and overall market shares. Moreover, we provide conditions under which screening efforts are reduced by competition. In such situations the quality of the overall loan portfolio declines and the economy incurs higher aggregate risk due to the lower quality of banks' information production. The welfare gains from integrating fragmented loan markets can actually be negative.
