Spatial competition among financial service providers and optimal contract design

Abstract

The authors present a contract-based model of industrial organization that considers in a unified way both different information frictions (moral hazard, adverse selection, both) and a variety of market structures (monopoly, imperfect competition, various strategic interactions). The authors show how this method can be applied to the spread of the banking industry in emerging market countries, emphasizing observed transitions, namely the geographic locations of branches. Local collusive monopoly organizations and Bertrand-like competitive environments in location and utility space are considered alongside with frictions affecting the outcome, namely provincial spatial costs and the information structure. Mixed environments with fully informed local incumbents and entrants facing adverse selection are analyzed. The larger goal, beyond calibrated numerical examples, is to develop a framework with an operational toolkit for empirical work. This research was funded under the Private Enterprise Development in Low-Income Countries (PEDL) Programme