Effects of Competitive Structure on Loan Pricing and Credit Provisioning in Oligopolistic Banking Industry

This chapter presents results that contrast outcomes in banking industry following a simultaneous non-cooperative competition among banks of roughly similar sizes vis-a-vis a sequential move competition between a leader and other follower banks. We also present results that link credit demand and bank efficiency (defined as the cost that it takes a bank to make loans) with liquidity creation and the total supply of liquidity in the market. We find that in a banking industry characterized by a sequential move competition with some leaders and other followers, aggregate credit generation may be larger, and price of loans may be cheaper in comparison to a situation where similarly sized banks compete simultaneously. This critical insight calls for special care that should be taken while regulating banks that are commonly perceived to be “too large” or “too big to fail.” We also present results that connect the effects of cost-reducing investments in the banking industry on credit supply and loan pricing. We also briefly review the vast and ever-expanding scholarship on bank competition and its economic impacts.

Keywords: Bank competition, banking profits, competitive structure, credit market, financial intermediation, loan origination, loan pricing, market liquidity, oligopolistic banking industry, simultaneous move game, sequential move game.