Strategic pricing of the interest rate is a central feature of models of competition among financial institutions (Dinc, 2000; Villas-Boas and Schmidt-Mohr, 1999; Peterson and Rajan, 1995; Riordan, 1993; Besanko and Thakor, 1993 and 1987). In many countries, however, especially developing ones, financial markets remain highly regulated. Interest rates are set by the government, typically below market-clearing levels, and inter-bank lending is restricted. In such environments, banks are limited in their ability to price and lend strategically, so that the effects of competition may be different.
In financially repressed systems, a natural tendency arises for alternative institutions to emerge to meet the credit needs of excluded borrowers. Most of the existing literature describes such markets as segmented. However, in many instances, alternative institutions also compete directly with existing banks for deposits and borrowers.
Such competitors (e.g., private banks, credit cooperatives, rotating savings and credit associations ROSCAs, moneylenders) often are not subject to the same interest rate controls as formal financial institutions or find ways to circumvent restrictions. Their presence may affect the behavior, profitability, and intermediation role of incumbent banks.
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Competition Under Credit Rationing: Theory and Evidence from Rural China
