Banking Market Structure, Credit Supply and Default Risks

Abstract

This study addresses two related questions. First, how does market structure influence a bank’s decision to originate new residential single-family home mortgages? Second, how is mortgage default risk affected by market concentration? We use data on banks and mortgages in non-agency securitization pools for the period from 1999 to 2008 to explore these questions. We adopt a two-stage approach to test the effects of banking market structure on credit supply and default risk across ZIP code areas. We find that banks operating in markets with low entry barriers (efficient banks) increase credit supply, while banks possessing market power restrict credit supply to mortgage markets. Banks with market power originate loans that have lower default risk compared to loans originated by banks in competitive markets. Efficient banks use mortgage technology indiscriminately to increase credit supply even at the expense of lowering credit quality (increasing default risks). We also show that the banking market structure effects are not correlated with legislation risks and population size in the markets.