Market Structure in Banking and Debt-Financed Project Risks

We study the relationship between market structure and risk-taking in lending markets. Introduction of loan market competition will reduce lending rates and increase credit market fragility regardless of whether borrowers have access to investment projects displaying first-order or second-order stochastic dominance. We establish how fragility becomes a matter of increasing concern as we shift from a mean-increasing investment technology to one displaying a mean-preserving property. Our analysis identifies a systematic relationship between the agency costs of debt in the sense of distorted investment decisions and the character of the investment technology.