Banking concentration and loan-rate markups in a frictional loan market

We present a model of frictional lending where entrepreneurs choose their outside options (self-finance or waiting to find other lenders) when bargaining with banks. When the number of banks is sufficiently small, the equilibrium features self-finance as entrepreneurs’ dominant outside option; when the number of banks is sufficiently large, waiting becomes the dominant outside option. The model can rationalize the mixed empirical evidence on the relationship between banking concentration and loan-rate markups. It also uncovers new policy-dependent channels through which the concentration-markup relationship need not be stable or positive. Depending on the equilibrium regime, monetary policy can alter entrepreneurs’ outside options and change how banking concentration affects loan market power. Our main insight extends to cases with endogenous entry of banks or entrepreneurs, prudential regulation, and default risk.