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Market-Based Solutions to Vital Economic Issues


Kenan Institute 2024 Grand Challenge: Business Resilience
Market-Based Solutions to Vital Economic Issues
Dec 11, 2022

Lending Competition and Funding Collaboration


We study competition and collaboration between a bank and a shadow bank that lend in the same market plagued by adverse selection. The bank has cheaper funding, whereas the shadow bank is endowed with a better screening technology. Our innovation is to allow the bank to lend to the shadow bank, i.e., to finance its competitors. This interbank arrangement lowers shadow bank’s funding cost and reduces the bank’s incentive to compete. We show two lenders collaborate when the average quality of the borrower pool is low but compete when the quality gets high. While the shadow bank always benefits from interbank financing, the bank receives more profits only when the average quality is high, at the expense of higher interest rates faced by the borrowers.

Note: Research papers posted on SSRN, including any findings, may differ from the final version chosen for publication in academic journals.  

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