More Competition, Less Information
A new study conducted by Filippo De Marco of Bocconi University's Department of Finance and Silvio Petriconi of the Catolica Lisbon School of Business and Economics, published in the Journal of Financial and Quantitative Analysis reveals that competition among banks significantly reduces the production of information about potential borrowers. This result emerges against a backdrop of deregulation of interstate branching in the United States, which has seen a decline in positive yields of loan announcements, especially for opaque and bank-dependent firms.
According to the study, increased bank competition has reduced banks' incentive to collect detailed information on borrowers, a phenomenon reflected in lower yields of loan announcements, especially in states that have deregulated interstate branches. This phenomenon is particularly pronounced for smaller, bank-dependent firms, which need more detailed information for accessing credit.
“Our study clearly shows that increased competition reduces the quality of information produced by banks about borrowers,” said Filippo De Marco. “This is particularly worrisome for opaque firms that rely heavily on banks to obtain credit." Silvio Petriconi adds, “The reduction in information production not only makes it more difficult for firms to obtain loans, but also increases the risk of covenant violations, undermining financial stability.”
At a time when bank competition is incentivized to improve access to credit and stimulate economic growth, this study offers a crucial counterpoint, underscoring that excessive competition can lead to decreased credit quality and increased financial risks. The current environment, marked by increasing deregulation, makes these findings particularly relevant to financial regulators and legislators.
The study is notable for its use of an innovative approach in measuring information production through cumulative abnormal returns to borrowers' shares after a loan announcement. It also uses detailed data from DealScan and a variety of robust methodologies to ensure the reliability of the results.
The implications of this study are far-reaching. As pointed out by De Marco and Petriconi, existing banks reduce information production to prevent their best customers from switching to competitors. This behavior, while understandable, has negative consequences for the credit market and economic stability. “Our research suggests that balanced regulation is essential to maintain a healthy and informed banking system,” De Marco concluded.
