We investigate the interaction between banks' use of information acquisition as a strategic tool and their role in promoting the efficiency of credit markets when a bank's ability to gather information varies with its distance to the borrower. We show that banks acquire proprietary information both to soften lending competition and to extend their market share. As competition increases, investments in information acquisition fall, leading to lower interest rates but also to less efficient lending decisions. Consistent with the recent wave of bank acquisitions, we also find that merging for informational reasons with a competitor is an optimal response to industry consolidation.

We examine how the informational structure of loan markets interacts with banks' strategic behavior in determining lending standards, lending volume, and the aggregate allocation of credit. We show that, as banks obtain private information about borrowers and information asymmetries across banks decrease, banks may loosen their lending standards, leading to an equilibrium with deteriorated bank portfolios, lower profits, and expanded aggregate credit. These lower standards are associated with greater aggregate surplus and greater risk of financial instability. We therefore provide an explanation for the sequence of financial liberalization, lending booms, and banking crises observed in many emerging markets.

Regulatory changes and technological advances have profoundly affected the competitive landscape of credit markets. In this paper, we investigate how intermediaries alter their infor-mation acquisition strategies in response to increased competition. We specify a model where the severity of asymmetric information between banks and borrowers increases with their infor-mational distance. As the number of active banks grows, investments in information acquisition initially fall with returns to informed intermediation. However, when a critical investment threshold is reached, further entry leads to specialization. Intermediaries optimally refocus in-formational resources in their core markets by retrenching from peripheral segments to fend off competitive threats to their captive customer base. The incentive to concentrate informational resources increases in the degree of adverse selection in the market. 1