Lending market structure and monitoring incentives

Abstract

This article introduces a model of bank lending analyzing the interaction between the incentives for ex ante customer monitoring and the lending market structure. In particular, it raises the issue of whether a monopoly bank has stronger incentives than duopoly banks to monitor the creditworthiness of customers with no credit history. Monitoring competition is indeed shown to undermine the incentives to avoid particularly the decision errors regarding good risk projects. We show that the same conclusion is valid also for the evaluation of bad risk risks provided that the lending rate competition is not too intense. These results point to the need of evaluating the welfare implications of monitoring competition in lending markets. Our article offers such an analysis.