Double banking competition and strategic acquisition of screening technology

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Double Banking Competition and Strategic Acquisition of Screening Technology? Jung-Hyun AHN† EconomiX- University of Paris X Current version: March 13, 2007 Abstract In the last couple of decades, banks have developed credit scoring system as a technology to evaluate the credit-worthiness of their potential borrowers. This article analyses the e?ect of the introduction of this new screening technology on credit availability and loan quality when banks compete both in loan market and in bank fund market. We show that, in a double competition set-up, banks can renounce their sector specific technology in spite of its competitive advantage compare to new technology in its own sector. Even if a bank is capable of enjoying monopoly profit in its own loan sector, it cannot survive if this monopoly rent is not enough to pay for funding cost. On the other hand, once competition for fund is achieved, competition for loan rate is constrained by the rate for fund determined in the former stage. It is thus important for bank to move to the sector where maximum return that banks can withdraw is the highest. This double competition thus results in decreases in credit availability and granted loan quality in some sectors. Keywords: double banking competition, screening, information acquisition, credit scoring JEL classification: G21, D82, L14, L15 ?I particularly thank Vincent Bignon, Régis Breton, Xavier Freixas, Bertrand Gobillard, Marcello Messori and Laurence Scialom for their stimulating discussions and their remarks.

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DoubleBankingCompetitionandStrategicAcquisitionofScreeningTechnology∗Jung-HyunAHN†EconomiX-UniversityofParisXCurrentversion:March13,2007AbstractInthelastcoupleofdecades,bankshavedevelopedcreditscoringsystemasatechnologytoevaluatethecredit-worthinessoftheirpotentialborrowers.Thisarticleanalysestheeﬀectoftheintroductionofthisnewscreeningtechnologyoncreditavailabilityandloanqualitywhenbankscompetebothinloanmarketandinbankfundmarket.Weshowthat,inadoublecompetitionset-up,bankscanrenouncetheirsectorspeciﬁctechnologyinspiteofitscompetitiveadvantagecomparetonewtechnologyinitsownsector.Evenifabankiscapableofenjoyingmonopolyproﬁtinitsownloansector,itcannotsurviveifthismonopolyrentisnotenoughtopayforfundingcost.Ontheotherhand,oncecompetitionforfundisachieved,competitionforloanrateisconstrainedbytherateforfunddeterminedintheformerstage.Itisthusimportantforbanktomovetothesectorwheremaximumreturnthatbankscanwithdrawisthehighest.Thisdoublecompetitionthusresultsindecreasesincreditavailabilityandgrantedloanqualityinsomesectors.Keywords:doublebankingcompetition,screening,informationacquisition,creditscoringJELclassiﬁcation:G21,D82,L14,L15∗IparticularlythankVincentBignon,RégisBreton,XavierFreixas,BertrandGobillard,MarcelloMessoriandLaurenceScialomfortheirstimulatingdiscussionsandtheirremarks.Ialsothanktheparticipantsfor23rdSymposiumonMoney,BankingandFinance(Lille,France;June2006)andtheseminarofEconomiX,UniversityofParisX(April,2006)fortheearlierversion.Allremainingerrorsaremyown.†Address:MaisonMaxWeberK-126,UniversityofParisX,200,avenuedelaRépublique92001NanterreCEDEX,France;Tel:33140975914;Fax:33140977886;e-mail:jung-hyun.ahn@u-paris10.fr1

1IntroductionInthelastcoupleofdecades,bankshavedevelopedanewtechnologytoevaluatethecredit-worthinessoftheirpotentialborrowers,so-calledcreditscoringsystem.Atthebeginning,ithasbeenusedinconsumercreditmarketsuchasmortgages,creditcardandautomobilecredits.Sincemid-1990s,bankshaveenlargeditsreachtosomesmallbusinesssectors(BergerandFrame2005).Inspiteofitsincreasingimportanceasaninformationacquisitiontechnologywithinbanks,toourknowledge,fewtheoreticalstudiesanalyseditsimpacts.Itseemstousthatthisemergenceofthenewtechnologyshouldhaveaneﬀectoncompetitionandeﬃciencyinbankingsectorthoughitseﬀectisnoteasytoisolate.Thisarticleanalysestheeﬀectoftheintroductionofthisnewtechnologyonbankingcompetition.Inadoublecompetitionset-upwherebankscompetebothintheloanmarketandinbankfundmarket,wedemonstratethattheintroductionofnewtechnologycandecreasecreditavailabilityandalsothequalityofgrantedloansinsomesectors.Oneoftheimportantadvantagesofthisnewscreeningtechnologyconcernsthefactthatevaluationisprincipallybasedonpublicallyaccessibleinformationfromtheﬁnancialmarketorexternalcreditregistryinstitutions,e.g.balancesheetofﬁrms,theirﬁnancialstatement,theircollateralvalue,theirrepaymentrecordandtheirdebtoutstandingetc.(BergerandUdell2002,SaundersandAllen2002).Itthuslowerscostforscreeningontheirpotentialborrowers(Berger,FrameandMiller2002).ThisissueisespeciallypertinentforsomecountriesliketheU.S.wherebankscanobtaincreditscoringdatabaseonpotentialborrowersfromexternalcreditbureaus(e.g.Fair,IsaacandCo.)withoutdevelopinginternalmodelforbankstosynthesizethecollectedinformation.Thisallowsbankstomoreeasilypenetrateloansectorsinwhichtheydonotinitiallypossessexpertise.Whenabankentersaloansectorinwhichitpreviouslyhadnopresenceandcompeteswiththeincumbentbankthatpossessessector-speciﬁcexpertise,theformerfacesmoresevereadverseselectionproblemaboutitsloanapplicantsthanthelatterdoes.Thenewentrantisobligedtochargeahigherratethanincumbentbanks,whichdiscouragestheformerfromen-tering.Thisplaysaroleasabarriertoentry.Butlowerscreeningcostofthenewtechnologyalleviatesthisbarriertoentryinducedbyinformationalasymmetryintheloanmarket.Banks,ingeneral,shouldbeconfrontedwithmorecompetitionthanthecasewherebanks’informa-2

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