Lazy Entrepreneurs or Dominant Banks? An Empirical Analysis of the Market for SME Loans in the UK

Abstract

An encompassing model of a business loan contract with the bank is constructed to establish the roles and relative importance of asymmetry of information, market power, borrower (entrepreneurial) effort and quality in explaining contract features. Special cases of the model include symmetric versus asymmetric information regimes, competition versus monopoly power, adverse selection versus moral hazard. The model is tested on a large SME database from a large UK bank. Results indicate that the model is a good description of the data; that the bank has considerable market power; and that there is moral hazard but no adverse selection in the market

Keywords: optimal loan contracts, adverse selection, moral hazard, symmetric information, monopoly, empirical contract theory

JEL Classification: D82, G21