deposits, can lead to departures from the competitive outcome as banks may want to corner one market to achieve monopoly in the other.
Broecker (1990) analyzes how competition in the credit market affects the screening of borrowers by banks when borrowers are of heterogeneous quality and screening tests are imperfect. The main result is that competition worsens the “winner’s curse” problem as a higher loan rate tends to worsen the quality of firms accepting the loan. Increasing the number of banks reduces firms’ average credit-worthiness and raises the probability that a bank does not grant any loan. In the limit, the equilibrium maintains some degree of oligopolistic competition. The lower quality of borrowers as competition increases implies also an increase of loan rates to compensate for the higher portfolio risk (Marquez, 2002); but not when information acquisition is endogenous, since in this case banks acquire information to soften competition and more competition reduces the winner’s curse problem (Hauswald and Marquez, 2006). The presence of adverse selection affects also the structure of the industry, as it generates endogenous entry barriers and leads to equilibria with blockaded entry, where only a finite number of banks is active (Dell'Ariccia et al., 1999; Dell’Ariccia, 2001).
Switching costs are an important source of market power in retail banking. In moving from one bank to another, consumers incur costs associated with the physical change of accounts, bill payments or lack of information (Vives, 2001a). The competitive effects of switching costs are twofold. On the one hand, they lead to the exercise of market power once banks have established a customer base which remains locked in. On the other hand, they induce fierce competition to enlarge the customer base. Thus, switching costs may lead banks to offer high deposit rates initially to attract customers and to reduce them subsequently, when consumers are locked in. Different results may however be obtained when switching costs are combined with asymmetric information about borrowers' credit- worthiness (Bouckaert and Degryse; 2004).
Finally, the presence of networks also affects the degree of competition as it introduces elements of non-price competition in the interaction among banks. For example, the