Competitive Loan Market Research Articles

Bank net worth and frustrated monetary policy

I present a model in which bank net worth determines both loan market competition and monetary transmission to firm borrowing rates. In the model, banks are local monopolists for borrowers near them. When they are flush with equity, banks expand their lending, compete for customers at the edges of their markets, and pass through changes in the monetary policy rate to their loan rates. When they lose substantial equity, banks consolidate, retreat from rivalry, and frustrate monetary transmission. The model explains why interest rate pass-through weakens after financial crises. Its predictions are consistent with several facts about bank-to-firm lending.

Competition and Profitability in the Chinese Banking Industry: New Evidence from Different Ownership Types

This paper tests the competition in different banking markets in China (deposit, loan, and non-interest income markets) using a sample of Chinese commercial banks (state-owned, joint-stock, and city commercial banks) over the period 2003–2013 and further examines the impact of competition on bank profitability for the whole sample and also for different ownership types. The results show that non-interest income market in the Chinese banking industry has a higher level of competition compared to the other two markets during the early years of the examined period. The findings further report that in a higher competitive deposit market, Chinese commercial banks have lower levels of profitability. Finally, the results suggest that a higher competitive loan market leads to higher profitability of all these three types of banks while the impact of deposit market competition is significant and negative.

Bank Information Sharing and Liquidity Risk

We propose a novel rationale for the existence of bank information sharing schemes. Banks may voluntarily disclose borrowers' credit history to maintain asset market liquidity. By sharing such information, banks mitigate adverse selection when selling their loans in secondary markets. This reduces the cost of asset liquidation in case of liquidity shocks. Information sharing arises endogenously when the liquidity benefit dominates the cost of losing market power in the primary loan market competition. We show banks having incentives to truthfully disclose borrowers' credit history, even if such information is non-verifiable. We also provide a rationale for promoting public credit registries.

Study on the impact of Taiwan's deposit and loan market competition on the risk bearing of the bank

The “third financial reforms” in Taiwan set off a wave of merger and reorganization of the banking. In this paper, by constructing the Lerner Index of commercial bank deposit and loan market, it is found that the degree of competition in the loan market of commercial banks in Taiwan is decreasing, and the competition degree of the deposit market is rising. Based on the balance panel data of Taiwan's commercial Banks from 2012 to 2014, the paper empiricised the impact of the competition on the bank's deposit and loan market on its risk-taking behavior after the “third financial reform”. The research conclusion shows that :(1) the competition of commercial bank loan market and its risk bearing are”U”type relationship; (2) the deposit market competition can significantly reduce the risk of commercial Banks; (3) the assets scale of commercial Banks has contributed to the relationship between their “deposit market forces --financial fragility”; (4) the capital of commercial Banks can effectively enhance the degree of the loan market forces’ inhibition of bank risk behaviors.

Correspondence Analysis of Indonesian Retail Banking Personal Loans Top Up

Customer experience can be developed through good database management, and this is an important thing to do in the era of tough retail banking competition especially in the personal loan market competition. Through good database management, banks can understand the transaction pattern and customer behavior in each bank service’s contact point. This research aimed at identifying the personal loans correspondence between socioeconomic variables and top up transaction by using the secondary data from one of Indonesian retail banking. The research method used the correspondence analysis and regression. The result of the research showed that the socioeconomic factors that influenced the debtors to top up personal loans at the confidence level of 5% (0.05) included Age, Marital Status, Dependent Number, Living Status, Education, Region, Job Type, Work Length, Salary, Debt Burdened Ratio (DBR), Credit Tenure, and Credit Limit, and only Gender had no effect on personal loan top up. The socioeconomic factors that were close correspondence with the personal loan top up transactions included bachelor degree, State-Owned Enterprises and goverment civil servant employee, income starting from Rp 5 million, credit period starting from 4 years, dan credit limit starting from Rp 50 million. The findings in this study are expected to be useful for marketers of the banks in developing personal loan products and also in preparing a more targeted marketing strategy so that it becomes more effective and efficient for the banks. In addition, the expected implication is that the customer experience will be better because the product developed will be more customer centric. Keywords: bank, correspondence analysis, personal loans, regression, top up

Bank Net Worth and Frustrated Monetary Policy

Abstract I present a model in which bank net worth determines both loan market competition and monetary transmission to firm borrowing rates. In the model, banks are local monopolists for borrowers near them. When they are flush with equity, banks expand their lending, compete for customers at the edges of their markets, and pass through changes in the monetary policy rate to their loan rates. When they lose substantial equity, banks consolidate, retreat from rivalry, and frustrate monetary transmission. The model explains why interest rate pass-through weakens after financial crises. Its predictions are consistent with several facts about bank-to-firm lending.

Information Reliability, Organizational Bank Structure, Interbank Competition and Relationship Lending Benefits

In this paper we study how does bank–borrower relationships benefits differ depending on three factors identified in the theoretical literature: verifiability of information, bank’s organizational structure and interbank competition. We employ an empirical model that simultaneously accounts for all three of these factors to analyse how relationship lending affects credit cost. Our key result is that that borrowers with long relationship length are likely to be captured and deprived of larger rents and that the diversification of banking products moderate the hold-up problem. These latter findings suggest the possibility that relationship borrowers may suffer from capture effects. Moreover, we find evidence that close relationships benefit on credit cost is larger in a more competitive loan market. So, banks consider relationships as a device for product differentiation.

The cyclicality of bank regulation in a general economic framework

This article utilizes a representative agent model to address how the regulation policies for banks should respond to the general economic condition. With the consideration of a self-fulfilling deposit insurance facility with sufficient bank reserve to meet the expected need of liquidity shock, our model suggests a counter-cyclical capital adequacy requirement in a competitive loan market. The exception might occur when the moral hazard problem becomes very unwieldy and the representative individual is rather risk averse. With regard to the closure policy, we find that it is closely related to the individual’s degree of risk aversion. A counter-cyclical closure policy is recommended when the individual is highly risk averse. Otherwise, a pro-cyclical closure policy is preferred.

Choice of rating technology and loan pricing in imperfect credit markets

Accurate rating systems are of central importance for banks to price and manage their loan portfolios. A bank's choice to invest in a more accurate rating technology is based on a trade-off: the better rating system usually comes at higher cost, but endows the bank with a competitive advantage, which includes potentially better access to funds. This paper models the rating technology choice of a bank as a two-stage game in an oligopolistic banking sector. In the first stage banks choose between two alternative rating technologies that provide estimates about a borrower's default probability with varying precision. In the second stage banks set their loan prices based on estimated default probabilities in an imperfectly competitive loan market. While rating technology investment is lumpy and characterized by fixed costs, loan prices vary continuously with their markup over the risk-free rate of interest. The interaction of loan pricing and rating technology investment gives rise to the following predictions: equilibrium adoption of the new rating technology need not increase individual banks' profits; identical banks in a symmetric banking sector might adopt the more accurate rating technologies sequentially rather than simultaneously; and increased competition in the banking sector slows investment in the new rating technology.

Are hazard models superior to traditional bankruptcy prediction approaches? A comprehensive test

In recent years hazard models, using both market and accounting information, have become state of the art in predicting firm bankruptcies. However, a comprehensive test comparing their performance against the traditional accounting-based approach or the contingent claims approach is missing in the literature. Using a complete database of UK Main listed firms between 1979 and 2009, our Receiver Operating Characteristics (ROC) curve analysis shows that the hazard models are superior to the alternatives. Further, our information content tests demonstrate that the hazard models subsume all bankruptcy related information in the Taffler (1983)z-score model as well as in Bharath and Shumway (2008) contingent claims-based model. Finally, using a mixed regime competitive loan market with different costs of misclassification, the economic benefit of using the Shumway (2001) hazard model is clear, particularly when the performance is judged with return on risk weighted assets computed under Basel III.

Securitization, competition and monitoring

We analyze the impact of loan securitization on competition in the loan market. Using a dynamic loan market competition model where borrowers face both exogenous and endogenous costs to switch between banks, we uncover a competition softening effect of securitization that allows banks to extract rents in the primary loan market. By reducing monitoring incentives, securitization mitigates winner’s curse effects in future stages of competition thereby decreasing ex ante competition for initial market share. Due to this competition softening effect, securitization can adversely affect loan market efficiency while leading to higher equilibrium profits for banks. This effect is driven by primary loan market competition, not by the exploitation of informational asymmetries in the secondary market for loans. We also argue that banks can use securitization as a strategic response to an increase in competition, as a tool to signal a reduction in monitoring intensity for the sole purpose of softening ex ante competition. Our result suggests that securitization reforms focusing exclusively on informational asymmetries in markets for securitized products may overlook competitive conditions in the primary market.

Securitization, Competition and Monitoring.

We analyze the impact of loan securitization on competition in the loan market. Using a dynamic loan market competition model where borrowers face both exogenous and endogenous costs to switch between banks, we uncover a competition softening effect of securitization that allows banks to extract rents in the primary loan market. By reducing monitoring incentives, securitization mitigates winner’s curse effects in future stages of competition thereby decreasing ex ante competition for initial market share. Due to this competition softening effect, securitization can adversely affect loan market efficiency while leading to higher equilibrium profits for banks. This effect is driven by primary loan market competition, not by the exploitation of informational asymmetries in the secondary market for loans. We also argue that banks can use securitization as a strategic response to an increase in competition, as a tool to signal a reduction in monitoring intensity for the sole purpose of softening ex ante competition. Our result suggests that securitization reforms focusing exclusively on informational asymmetries in markets for securitized products may overlook competitive conditions in the primary market.

Impact of bank competition on the interest rate pass-through in the euro area

This article analyses the impact of loan market competition on the interest rates applied by euro area banks to loans during the period 1994–2004, using a novel measure of competition called the Boone indicator. We find evidence that stronger competition implies significantly lower spreads between bank and market interest rates for most loan market products, in line with expectations. This result implies that stronger competition causes both lower bank interest rates and a stronger pass-through of market rate changes into bank rates. Evidence of the latter is also presented by our Error Correction Model (ECM) for bank rates. Further, banks compensate income losses from increased loan market competition by offering lower deposit rates. Our findings with respect to the loan market rates have important monetary policy implications, as they suggest that measures to promote competition in the European banking sector are likely to render the monetary policy transmission mechanism more effective.

A note on selling distressed loans with bank bailouts: modelling of bank interest margins with default probabilities

This article extends the framework of Merton (1974) with Vassalou and Xing (2004) to value a troubled but solvent bank's equity by explicitly incorporating distressed assets purchased by the government in an imperfectly competitive loan market. We show that the bank may be willing to take this bailout when the purchased amount is relatively small and the margin is relatively low. However, the bank may be harder to entice even when the unit price of the bailed-out assets subsidized by the government is relatively high. As a consequence, most of the first half of the Troubled Asset Relief Program's money is not used to buy troubled assets (Wilson, 2010).

A New Rationale for Debt Covenants: The Trade-Off between Short-Term and Long-Term Debt

When a debt covenant is violated the lender has the right to demand immediate repayment of the loan. Using this right, the lender can extract certain concessions from the borrower (manager), which may be inefficient. I propose a theory that explains why, despite this inefficiency, tight and often violated debt covenants may be optimal. In a repeated moral hazard problem combined with an incomplete contract set-up, the debt overhang prevents the manager from exercising optimal effort. I deviate from the standard incomplete contract set-up by allowing outside market participants to observe the uncontractable outcome. I model the manager's outside option as the opportunity to refinance his debt on a competitive loan market. In this situation, the market independently evaluates the manager's performance based on observable parameters. The value of the outside option has an important impact on the covenant design. A strict covenant will severely punish the manager if his outside option is low. If the covenant is violated the lender will have control over the manager's assets and the manager will face a renegotiation game in which the lender has all the bargaining power. In this case a high outside option allows the manager to retain some rents. The manager will exercise effort to increase his chances to have a high outside option.

The Competitive Advantage of Incumbents: Evidence from Newly Liberalized Banking Industries

The paper analyzes banking competition in newly liberalized banking industries, where the incumbent banks still dominate the deposit market but are exposed to substantial loan market competition. We argue that incumbent banks, due to their preferential position in the deposit market, are able to generate higher margins than new entrants. Moreover, margins of new entrants are negatively affected by the incumbents' preferential position in the deposit market. The analysis is based on data from 296 banks from ten Central and Eastern European countries for the period 1995-2004.

Loan Sales and Loan Market Competition*

ABSTRACTIn this article, I suggest a theoretical explanation for the recent spectacular growth of the loan sales market in terms of both quantity and quality. I show that banks can use loan sales as a strategic tool in order to preserve their informational advantage in a competitive environment. I consider a two‐period competition model where banks acquire private information about their clientele during the lending relationship and where there is informational asymmetry in the loan sales market. In spite of the information dilution costs incurred in selling high‐quality loans, banks have an incentive to imitate low‐quality loan holders by selling their loans in order to avoid communicating negative signals about the quality of their clientele to potential competitors. As a result, loan market competition can lead to the emergence of a liquid loan sales market in which both low‐ and high‐quality loans coexist, thereby improving the quantity and quality of the loan sales market.

Bank loan commitments and Material Adverse Change clause

As Ergungor (2001) indicated, some critical problems still exist in the valuation of bank loan commitments. One of them is the Material Adverse Change (“MAC”) clause as a contractual discretion that may be exercised by banks. We explain how the MAC clause can affect the value of bank loan commitments in the competitive loan market.

Loan Market Competition and Bank Risk-Taking

Recent literature (Boyd and De Nicoló, J Finance 60:1329–1343, 2005) has argued that competition in the loan market lowers bank risk by reducing the risk-taking incentives of borrowers. Using a model where competition arises from falling switching costs for entrepreneurs, we show that the impact of loan market competition on banks is reversed if banks can adjust their loan portfolios. The reason is that when borrowers become safer, banks want to offset the effect on their balance sheet and switch to higher-risk lending. They even overcompensate the effect of safer borrowers because loan market competition erodes their franchise values and thus increases their risk-taking incentives.

Securitization, Competition and Efficiency

This article analyzes the motivation for loan securitization and its effect on loan market efficiency. We consider a two-period loan market competition model in which period 2-competition is affected by the winner's curse. This increases ex ante competition for a greater initial market share. Given that securitization transfers a part of the return from loans to other investors, banks can use it as a tool to signal that they will reduce monitoring, for the purpose of softening ex ante competition. Thus, securitization adversely affects loan market efficiency while it leads banks to increases collectively their profits. This effect is driven by primary loan market competition, not by the exploitation of informational asymmetries in the secondary market for loans.