Foreign Entry and Bank Competition

Foreign entry and bank competition are modeled as the interaction between asymmetrically informed principals: the entrant uses collateral as a screening device to contest the incumbent’s informational advantage. Both ex ante better information and ex post stronger legal protection are shown to facilitate the entry of low-cost outside competitors into credit markets. The entrant’s success in gaining borrowers of higher quality by o¤ering cheaper loans increases with its e¢ ciency (cost) advantage. This paper accounts for evidence suggesting that foreign banks tend to lend more to large …rms thereby neglecting small and medium enterprises. The results also explain why this observed "bias" is stronger in emerging markets.