Monitoring and market power in credit markets

Whether or not banks are engaged in monitoring of customers (information acquisition) may have important consequences to the whole economy. Theory suggests an inverse relation between both average loan interest rates and credit losses, and banks' investments in monitoring. In contrast, investments in market power result in a direct relation. These predictions are tested using panel data on Finnish local banks. We find evidence that banks' investments in branch network density and human capital (personnel) contribute more to monitoring than to market power. We also find that managing the money transactions of customers enables banks to better control risks in their lending. (C) 2003 Elsevier B.V. All rights reserved.