How changes in market conditions affect screening activity, credit risk, and the lending behaviour of banks.

Papanikolaou, N.I., 2019. How changes in market conditions affect screening activity, credit risk, and the lending behaviour of banks. European Journal of Finance. (In Press)

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DOI: 10.1080/1351847X.2018.1548367

Abstract

The global financial crisis dramatically transformed the market conditions in the banking industry. We construct a theoretical model of spatial competition that considers the differential information between lenders and loan applicants to explore how changes in the market structure affect the lending behaviour of banks and their incentives to invest in screening and how this, in turn, affects the level of credit risk in the economy. Our findings reveal that enhanced competition reduces lending cost thus encouraging the entry of new customers in credit markets. Also, that the transportation cost that loan applicants are required to pay to reach the bank of their interest shrinks with respect to the degree of competition. We further lend support to the view that stiffer competition has an increasing impact on the level of credit risk. Notably, we find that competition strengthens the incentives of banks to engage in screening activity and that screening serves as a protection mechanism that can provide banks with a shield against bad loans. Overall, when market conditions are substantially distorted, this has a dilutive impact on the incentives mechanism of banks to screen their applicants. We provide empirical evidence which is consistent with the conceptual underpinnings of our theoretical model and the obtained findings.

Item Type:Article
ISSN:1466-4364
Uncontrolled Keywords:banking; market structure; spatial competition; screening; credit risk; financial crisis
Group:Faculty of Management
ID Code:31500
Deposited By: Unnamed user with email symplectic@symplectic
Deposited On:27 Nov 2018 09:38
Last Modified:27 Nov 2018 09:38

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