In the wake of the Global Financial Crisis, there has been quite a debate about the virtues and the peril of competitive pressures in the banking sector. In a paper, published few years back in the Comparative Economic Studies (Vol. 56, Issue 2, pp. 295-312, 2014 myself, Charles Larkin and Brian Lucey have touched upon some of the aspects of this debate.
There are, broadly-speaking two schools of thought on this subject:
The market power hypothesis – implying a negative relationship between bank competition and the cost of credit (as greater competition reduces the market power of banks and induces more competitive pricing of loans). This argument is advanced by those who believe that harmful levels of competition can lead to banks mispricing risk while competing with each other. The information hypothesis postulates a positive link between credit cost and competition, as the banks may be facing an incentive to invest in soft information.
This post was published at True Economics on Saturday, September 3, 2016.