Information asymmetry and competition in credit markets

Informational imperfection is a defining feature of credit markets. Asymmetry of information between lenders and borrowers renders credit markets special in several dimensions. One of these dimensions is the effect of lender competition on the availability and price of credit. Another are the determinants of lender competitiveness in the market. This dissertation contributes to the understanding of both these dimensions. Competition in credit markets can have a surprising detrimental effect on the availability of credit to informationally opaque borrowers, if it sufficiently decreases the return from investing in the acquisition private information about borrowers. Since competition also works on the opposite direction, for traditional reasons, its ultimate effect is an empirical question. Chapter 2 contains a theoretical setting in which the effect of competition on credit availability is ambiguous and, more importantly, analyzes empirically the circumstances under which competition is expected to be detrimental to availability of credit to small firms in the US. A related and complementary question is how asymmetry of information determines the level of lender competitiveness. This theoretical possibility is considered in chapter 3. A theory is presented in which adverse selection dampens the incentives lenders have to competing aggressively for borrowers. Also, this theory is tested using data on the market for overdraft loans in Brazil. Both these questions are important from a policy perspective. Better understanding of the effects of lender competition on credit availability helps assessing the effects of mergers that change the structure of the banking industry. If asymmetry of information dampens competition, then a new venue for active policy to improve lender competition is opened.