Bank reputation, bank commitment, and the effects of competition in credit markets

This article discusses the effects of credit market competitionon a bank's incentive to keep its commitment to lend to a borrowerwhen the borrower's credit quality deteriorates. It is shownthat, unlike in the borrower's commitment problem to keep borrowingfrom the same bank in 'good' times, the increased competitionmay strengthen a bank's incentive to keep its commitment. Banksoffer loans with commitment to the highest quality borrowersbut, when faced with competition from bond markets, they alsogive these loans to lower quality borrowers. An increase inthe number of banks has a non-monotonic effect; new banks reinforcea bank's incentive only if there are a small number of banks.