04 December 2024

CEPR: Breaking banks’ information monopoly: The case for deposit data sharing

Cao Garcia-Appendini, Huylebroek. Incumbent banks often maintain an informational monopoly over borrowers, making it difficult to switch to competing lenders or negotiate better terms. This column argues deposit relationships could be a solution.. contributing to more competitive lending markets.

Incumbent banks often maintain an informational monopoly over their borrowers, making it difficult to switch to competing lenders or negotiate better terms. This column argues that deposit relationships could be a solution, thereby contributing to more competitive lending markets. It shows that firms with deposit relationships at competing banks are significantly more likely to switch lenders. In turn, banks offer better loan terms to firms that maintained a deposit account with them. The findings have implications for current policy initiatives, such as open banking and data sharing, deposit market reform, and competition policy. 

A key challenge for policymakers aiming to improve small businesses' access to competitive financing is that incumbent banks maintain an information monopoly over their borrowers, making it difficult for small businesses to switch to competing lenders or negotiate better loan terms. This information monopoly essentially allows incumbent banks to charge higher interest rates and extract informational rents, leading to hold-up problems and investment inefficiencies (Sharpe 1990, Rajan 1992, Schenone 2010). In a recent paper (Cao et al. 2024), we uncover that deposit relationships could be a solution to this hold-up problem, thereby contributing to more competitive lending markets. In particular, we show that deposit relationships between firms and competing banks can mitigate incumbent banks’ information monopoly, thereby improving firms’ ability to switch to new lenders and obtain competitive loan terms.

The power of deposit relationships

Using comprehensive data on deposit and loan relationships between firms and banks in Norway, we find that deposit relationships significantly reduce incumbent banks' information advantage. This stems from the fact that when firms maintain deposit accounts with multiple banks, competing lenders can observe valuable information about the firm's financial health through their transaction history. This information helps level the playing field between incumbent and competing banks.

The impact is substantial. Our analysis shows that firms with deposit relationships at competing banks are eight percentage points more likely to switch lenders – a 50% increase over the baseline switching rate.

As shown in Figure 1, about 20% of firms maintain more deposit relationships than lending relationships, creating opportunities for increased competition. Furthermore, our data reveal that approximately 40% of firms that successfully switch lenders had a pre-existing deposit relationship with their new bank (Figure 2)....

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