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On the Coexistence of Banks and Markets

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  • Hans Gersbach
  • Harald Uhlig

Abstract

We examine the coexistence of banks and financial markets by studying a credit market where the qualities of investment projects are not observable and the investment decisions of entrepreneurs are not contractible. Standard banks can alleviate moral-hazard problems, while financial markets operated by investment banks can alleviate adverse-selection problems. In competition, standard banks are forced to increase repayments, since financial markets can attract the highest-quality borrowers. This, in turn, increases the share of shirkers and may make lending unprofitable for standard banks. The coexistence of financial markets and standard banks is socially inefficient. The same inefficiency may occur with the entrance of sophisticated banks, operating with a combination of rating and ongoing monitoring technologies. Copyright The editors of the "Scandinavian Journal of Economics" 2007 .

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Bibliographic Info

Article provided by Wiley Blackwell in its journal Scandinavian Journal of Economics.

Volume (Year): 109 (2007)
Issue (Month): 2 (06)
Pages: 225-243

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Handle: RePEc:bla:scandj:v:109:y:2007:i:2:p:225-243

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Cited by:
  1. Solomon, Bernard-Daniel, 2008. "Banks as Better Monitors and Firms' Financing Choices in Dynamic General Equilibrium," MPRA Paper 23958, University Library of Munich, Germany, revised 01 Jun 2010.

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