Information Technology and Bank Competition

Abstract

We consider a spatial model of bank competition to study how the development and diffusion of information technology affect competition in the lending market, stability of the banking sector, and social welfare. We find that the effects of an overall improvement in information technology depend on whether or not it weakens the influence of bank–borrower distance on monitoring/screening costs. If so, then competition intensifies and banks are less stable; otherwise, competition intensity does not vary and banks are more stable. In line with recent empirical evidence, we find that a technologically more advanced bank always commands greater market power and is more stable. The welfare effect of progress in information technology is ambiguous when such progress increases the intensity of competition. However, if banks have local monopolies then technological progress always improves social welfare.