Asymmetric information and the structure of the banking industry

We analyze the effects of informational asymmetries on the market structure of the banking industry in a multi-period model of spatial competition. In the process of lending, incumbent banks gather proprietary information about their clients, acquiring an advantage over potential entrants. We show that these informational asymmetries are important determinants of the industry structure and of banks' strategic behavior. Contrary to traditional models of horizontal differentiation. the steady-state equilibrium is characterized by a finite number of banks even in the absence of exogenous fixed costs. In addition, less concentrated industry structures may be associated with higher interest rates. (C) 2001 Elsevier Science B.V. All rights reserved.