Article first published online: 17th December 2002 DOI: 10.1111/0022-1082.00223
How will banks evolve as competition increases from other banks and from the capital market? Will banks become more like capital market underwriters and offer passive transaction loans or return to their roots as relationship lending experts? These are the questions we address. Our key result is that as interbank competition increases, banks make relationship loans, but each has lower added value for borrowers. Capital market competition relationship lending (and bank lending shrinks), but each relationship loan has greater added value for borrowers. In both cases, welfare increases for some borrowers but not necessarily for all.