INTEREST-RATE DIFFERENCES, BARGAINING ABILITY, AND IMPERFECT COMPETITION IN THE CREDIT MARKET

Regarding empirical interest-rate differences in credit markers the behaviour of borrowers and lenders can be described in a simple model. Banks assume that each debtor has an individual maximum capacity of debt service which leads to an individual budget constraint. Without having precise information on the number or conditions of rival offers banks will take them into consideration. While borrowers have to face search costs equilibrium dispersions of interest rates can be derived that leave a surplus to lenders and will not be diminished by imperfect competition. As a result high rated borrowers can use their bargaining ability to gain favourable credit terms while low rated borrowers pay higher interest rates which, however, doesn't reflect any kind of risk compensation.