In a recent blog post, I talked about whether there are trade-offs between bank competition and financial stability. But what about access to finance? What does competition imply for access?
Theory supplies conflicting predictions, as usual. According to standard economic theory, a banking system characterized by market power delivers a lower supply of funds to firms at higher cost; hence greater competition improves access. However, several theoretical contributions have shown that when we take into account problems of information asymmetry, this relationship may not hold. For example, banks with greater market power can have more of an incentive to establish long-term relationships with young firms and extend financing since the banks can share in future profits. In competitive banking markets, however, borrower-specific information may become more dispersed and loan screening less effective, leading to higher interest rates. Indeed, while it has been shown that concentration may reduce the total amount of loanable funds, it may also increase the incentives to screen borrowers, thereby increasing the efficiency of lending. However, all these models also assume a developed economy, with a high degree of enforcement of contracts and developed institutional environments in general. This is obviously not the case for most of the countries where the Bank works.