Free Banking and Information Asymmetry
AbstractA traditional argument against free banking is that it will collapse because of information externalities: it is impossible for depositors to tell whether a high deposit rate offered by a bank is due to its high efficiency or risky lending strategy. This paper shows that in a separating equilibrium a higher-quality bank offers a lower deposit rate and holds a smaller proportion of risky loans than a lower-quality bank to signal its underlying quality. Hence, free banking is not inherently unstable. The empirical results for the Hong Kong banking system during 1964-65 are consistent with the hypothesis of a separating equilibrium.
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Bibliographic InfoArticle provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.
Volume (Year): 31 (1999)
Issue (Month): 4 (November)
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Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879
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