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Free Banking and Information Asymmetry

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  • Chu, Kam Hon
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    Abstract

    A 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 Info

    Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

    Volume (Year): 31 (1999)
    Issue (Month): 4 (November)
    Pages: 748-62

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    Handle: RePEc:mcb:jmoncb:v:31:y:1999:i:4:p:748-62

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    Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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    Cited by:
    1. W. Bolt & A.F. Tieman, 2001. "Banking competition, risk and regulation," DNB Staff Reports (discontinued) 70, Netherlands Central Bank.

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