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Entry deterrence in banking: the role of cost asymmetry and adverse selection

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  • Mallick, Indrajit

Abstract

In this paper, we review and explore the strategic mechanisms that deter entry in banking. The literature relies on externality between banks to generate entry deterrence. Typically, the externality generated is caused by differential adverse selection faced by incumbents and entrants. In this paper it is shown that adverse selection problem between a bank and its borrowers is neither a necessary nor a sufficient condition for entry deterrence. We show that cost asymmetry between different types of incumbents and private information about costs can generate conditional entry deterrence. This source of externality can cause entry deterrence just as other types of externalities created by differential adverse selection. Forward contracts can act as signaling device for incumbent costs. Incorporating adverse selection problem in the credit market in fact relaxes entry conditions: entry can take place even if the incumbent is of strong type and can signal credibly.

Suggested Citation

  • Mallick, Indrajit, 2011. "Entry deterrence in banking: the role of cost asymmetry and adverse selection," MPRA Paper 32698, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:32698
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    References listed on IDEAS

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    1. Allen N. Berger & Seth D. Bonime & Lawrence G. Goldberg & Lawrence J. White, 1999. "The Dymanics of Market Entry: The Effects of Mergers and Acquisitions on De Novo Entry and Small Business Lending in the Banking Industry," Working Papers 99-13, New York University, Leonard N. Stern School of Business, Department of Economics.
    2. Allen N. Berger & Seth D. Bonime & Lawrence G. Goldberg & Lawrence J. White, 1999. "The dynamics of market entry: the effects of mergers and acquisitions on do novo entry and small business lending in the banking industry," Finance and Economics Discussion Series 1999-41, Board of Governors of the Federal Reserve System (U.S.).
    3. Berger, Allen N. & Mester, Loretta J., 1997. "Inside the black box: What explains differences in the efficiencies of financial institutions?," Journal of Banking & Finance, Elsevier, vol. 21(7), pages 895-947, July.
    4. Berger, Allen N. & Hanweck, Gerald A. & Humphrey, David B., 1987. "Competitive viability in banking : Scale, scope, and product mix economies," Journal of Monetary Economics, Elsevier, vol. 20(3), pages 501-520, December.
    5. Berger, Allen N. & Humphrey, David B., 1991. "The dominance of inefficiencies over scale and product mix economies in banking," Journal of Monetary Economics, Elsevier, vol. 28(1), pages 117-148, August.
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    Cited by:

    1. Lorenzo Esposito, 2014. "Con Annibale alle porte. L'internazionalizzazione del sistema bancario e il caso italiano," Moneta e Credito, Economia civile, vol. 67(266), pages 311-338.

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    More about this item

    Keywords

    Key Words: Entry Deterrence; Cost Asymmetry; Adverse Selection; Signaling;
    All these keywords.

    JEL classification:

    • C70 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - General
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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