Adverse Selection as a Barrier to Entry in the Banking Industry
Volume: Volume 30, No. 3
Issue: Autumn 1999
Pages: pp. 515-534
Authors: Giovanni Dell'Ariccia, Ezra Friedman, and Robert Marquez
Title: Adverse Selection as a Barrier to Entry in the Banking Industry
Abstract: Banks offering credit to borrowers are faced with uncertainty about their creditworthiness. If banks obtain information about borrowers after lending to them, they are able to reject riskier borrowers when refinancing. Potential entrant banks will face an adverse-selection problem stemming from their inability to distinguish new borrowers from old borrowers who have been rejected by their previous bank. We analyze the effects of asymmetric information on the market structure of the banking industry. We characterize the equilibrium under Bertrand competition with two banks, and show than an equilibrium where a third bank enters does not exist (blockaded entry).
JEL Classification
Banks; Other Depository Institutions; Mortgages (G210)
Production, Pricing, and Market Structure; Size and Size Distribution of Firms Concentration, Product Differentiation, Entry and Exit
(L110)
Business Credit (3153)
Financial Intermediaries (3140)
Commercial Banking (3120)
Market Structure: Industrial Organization and Corporate Strategy (6110)