Competition for Deposits, Risk of Failure, and Regulation in Banking
AbstractWe develop a model of banking competition for deposits based on modern financial intermediation theory and industrial organization analysis. The standard demand deposit contract makes banks vulnerable to failure and introduces (endogenous) expectations-based vertical differentiation. A multiplicity of equilibria exist due to a coordination problem among depositors. Minimum size investments and diversification economies accentuate the multiplicity problem and introduce the possibility of confidence crises. It is found that `excessive' competition is not responsible for the fragility of unregulated banking (the multiplicity problem) but nevertheless competition is socially excessive at bench-mark market equilibria. Our framework allows us to disentangle the effects of failure perceptions on rivalry. We find that a safer bank will command a higher margin and market share, and that in a symmetric equilibrium the possibility of failure softens competition. Further, fair and risk- based deposit insurance, even in the absence of moral hazard problems, induces competition above uninsured market levels introducing a rationale for deposit rate regulation. Our analysis provides a framework to assess the welfare trade-offs associated with deposit insurance, uncovering positive effects like extending the market and minimizing frictions, beyond well- known stabilizing consequences.
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Bibliographic InfoPaper provided by Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC) in its series UFAE and IAE Working Papers with number 193.92.
Length: 29 pages
Date of creation: 1992
Date of revision:
competition ; risk ; banks;
Other versions of this item:
- Carmen Matutes & Xavier Vives, 1992. "Competition for Deposits, Risk of Failure, and Regulation in Banking," CEPR Financial Markets Paper 0018, European Science Foundation Network in Financial Markets, c/o C.E.P.R, 77 Bastwick Street, London EC1V 3PZ.
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- Honohan, Patrick & Vittas, Dimitri, 1996. "Bank regulation and the network paradigm : policy implications for developing and transition economies," Policy Research Working Paper Series 1631, The World Bank.
- Marques Ibanez, David & Molyneux, Philip, 2002.
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- David Besanko & Anjan V. Thakor, 2004. "Relationship Banking, Deposit Insurance and Bank Portfolio Choice," Finance 0411046, EconWPA.
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