The Winner's Curse in Banking

Theoretical studies have noted that loan applicants rejected by one bank can apply at another bank, systematically worsening the pool of applicants faced by all banks. This study presents the first empirical evidence of this effect and explores some additional ramifications, including the role of common filters—such as commercially available credit scoring models—in mitigating this adverse selection; implications forde novobanks; implications for banks' incentives to comply with fair lending laws; and macroeconomic effects. The evidence supports the simple theory regarding loan loss rates but indicates a positive association between bank structure and income growth.Journal of Economic LiteratureClassification Numbers: G21, D80, L10.