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Financial opening, deposit insurance, and risk in a model of banking competition

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  • Cordella, Tito
  • Yeyati, Eduardo Levy

Abstract

This paper studies the impact of competition on the determination of interest rates, and on banks’ risk taking behaviour, under different assumptions about deposit insurance and the dissemination of financial information. We find that lower entry costs foster competition in deposit rates and reduce banks’ incentives to limit risk exposure. While higher insurance coverage amplifies this effect, two alternative arrangements (risk based contributions to the deposit insurance fund, and public disclosure of financial information) contribute to reduce it. Moreover, uninsured but fully informed depositors and risk based full deposit insurance yield the same, entry cost independent, equilibrium risk level. The welfare implications of the different arrangements are also explored.

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Bibliographic Info

Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 46 (2002)
Issue (Month): 3 (March)
Pages: 471-485

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Handle: RePEc:eee:eecrev:v:46:y:2002:i:3:p:471-485

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  1. Nicholas Economides & R. Glen Hubbard & Darius Palia, 1993. "The Political Economy of Branching Restrictions and Deposit Insurance: A Model of Monopolistic Competition Among Small and Large Banks," Working Papers 93-23, New York University, Leonard N. Stern School of Business, Department of Economics.
  2. Gerald P. O'Driscoll, 1988. "Bank Failures: The Deposit Insurance Connection," Contemporary Economic Policy, Western Economic Association International, vol. 6(2), pages 1-12, 04.
  3. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
  4. Yanelle, Marie-Odile, 1989. "The strategic analysis of intermediation," European Economic Review, Elsevier, vol. 33(2-3), pages 294-301, March.
  5. Matutes, Carmen & Vives, Xavier, 1995. "Imperfect Competition, Risk Taking, and Regulation in Banking," CEPR Discussion Papers 1177, C.E.P.R. Discussion Papers.
  6. Yanelle, Marie-Odile, 1997. "Banking Competition and Market Efficiency," Review of Economic Studies, Wiley Blackwell, vol. 64(2), pages 215-39, April.
  7. Matutes, Carmen & Vives, Xavier, 1996. "Competition for Deposits, Fragility, and Insurance," Journal of Financial Intermediation, Elsevier, vol. 5(2), pages 184-216, April.
  8. Frederic S. Mishkin, 1996. "Bank Consolidation: A Central Banker's Perspective," NBER Working Papers 5849, National Bureau of Economic Research, Inc.
  9. Ali, Mukhtar M & Greenbaum, Stuart I, 1977. "A Spatial Model of the Banking Industry," Journal of Finance, American Finance Association, vol. 32(4), pages 1283-1303, September.
  10. Chiappori, P.A. & Perez-Castrillo, D. & Verdier, T., 1992. "Spatial Competition in the Banking System: Localization, Cross Subsidies and the Regulation of Deposit Rates," DELTA Working Papers 92-15, DELTA (Ecole normale supérieure).
  11. Besanko, David & Thakor, Anjan V., 1992. "Banking deregulation: Allocational consequences of relaxing entry barriers," Journal of Banking & Finance, Elsevier, vol. 16(5), pages 909-932, September.
  12. Tito Cordella & Eduardo Levy Yeyati, 1998. "Public Disclosure and Bank Failures," IMF Staff Papers, Palgrave Macmillan, vol. 45(1), pages 110-131, March.
  13. Frederic S. Mishkin, 1992. "An Evaluation of the Treasury Plan for Banking Reform," Journal of Economic Perspectives, American Economic Association, vol. 6(1), pages 133-153, Winter.
  14. Blum, Jurg, 1999. "Do capital adequacy requirements reduce risks in banking?," Journal of Banking & Finance, Elsevier, vol. 23(5), pages 755-771, May.
  15. Steven C. Salop, 1979. "Monopolistic Competition with Outside Goods," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 141-156, Spring.
  16. Keeley, Michael C, 1990. "Deposit Insurance, Risk, and Market Power in Banking," American Economic Review, American Economic Association, vol. 80(5), pages 1183-1200, December.
  17. Jean-Charles Rochet & Jean Tirole, 1996. "Interbank lending and systemic risk," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 733-765.
  18. Caminal, Ramon & Matutes, Carmen, 2002. "Market power and banking failures," International Journal of Industrial Organization, Elsevier, vol. 20(9), pages 1341-1361, November.
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