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Bank Competition and Financial Stability: A General Equilibrium Exposition

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  • Gianni De Nicolò
  • Marcella Lucchetta

Abstract

We study the welfare properties of a general equilibrium banking model with moral hazard that encompasses incentive mechanisms for bank risk-taking studied in a large partial equilibrium literature. We show that competitive equilibriums maximize welfare and yield an optimal level of banks’ risk of failure. This result holds even though the risk of failure of competitive banks is higher than that of banks enjoying monopoly rents, and is robust to the introduction of social costs of bank failures. In this model, there is no trade-off between bank competition and financial stability.

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File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2013/wp-cesifo-2013-02/cesifo1_wp4123.pdf
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Bibliographic Info

Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 4123.

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Date of creation: 2013
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Handle: RePEc:ces:ceswps:_4123

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Related research

Keywords: general equilibrium; bank competition; financial stability;

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References

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  1. Lucy White & Alan D. Morrison, 2002. "Crises and Capital Requirements in Banking," OFRC Working Papers Series, Oxford Financial Research Centre 2002fe05, Oxford Financial Research Centre.
  2. Besanko, David & Kanatas, George, 1993. "Credit Market Equilibrium with Bank Monitoring and Moral Hazard," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 6(1), pages 213-32.
  3. Kwangwoo Park & George Pennacchi, 2007. "Harming depositors and helping borrowers: the disparate impact of bank consolidation," Working Paper, Federal Reserve Bank of Cleveland 0704, Federal Reserve Bank of Cleveland.
  4. John H. Boyd & Gianni De Nicoló & Bruce D. Smith, 2004. "Crises in competitive versus monopolistic banking systems," Proceedings, Federal Reserve Bank of Cleveland, Federal Reserve Bank of Cleveland, pages 487-509.
  5. Rafael Repullo & David Martínez-Miera, 2008. "Does Competition Reduce The Risk Of Bank Failure?," Working Papers, CEMFI wp2008_0801, CEMFI.
  6. Cordella, Tito & Yeyati, Eduardo Levy, 2002. "Financial opening, deposit insurance, and risk in a model of banking competition," European Economic Review, Elsevier, Elsevier, vol. 46(3), pages 471-485, March.
  7. Holmstrom, Bengt & Tirole, Jean, 1997. "Financial Intermediation, Loanable Funds, and the Real Sector," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 112(3), pages 663-91, August.
  8. John H. Boyd & Gianni De Nicolã, 2005. "The Theory of Bank Risk Taking and Competition Revisited," Journal of Finance, American Finance Association, American Finance Association, vol. 60(3), pages 1329-1343, 06.
  9. Gianni De Nicoló & Giovanni Favara & Lev Ratnovski, 2012. "Externalities and Macroprudential Policy," IMF Staff Discussion Notes, International Monetary Fund 12/05, International Monetary Fund.
  10. Alan D. Morrison & Lucy White, 2005. "Crises and Capital Requirements in Banking," American Economic Review, American Economic Association, American Economic Association, vol. 95(5), pages 1548-1572, December.
  11. Matutes, Carmen & Vives, Xavier, 1996. "Competition for Deposits, Fragility, and Insurance," Journal of Financial Intermediation, Elsevier, Elsevier, vol. 5(2), pages 184-216, April.
  12. Keeley, Michael C, 1990. "Deposit Insurance, Risk, and Market Power in Banking," American Economic Review, American Economic Association, American Economic Association, vol. 80(5), pages 1183-1200, December.
  13. Dell'Ariccia, Giovanni & Marquez, Robert, 2006. "Competition among regulators and credit market integration," Journal of Financial Economics, Elsevier, Elsevier, vol. 79(2), pages 401-430, February.
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Cited by:
  1. Elena Carletti & Agnese Leonello, 2014. "Credit Market Competition and Liquidity Crises," CESifo Working Paper Series 4647, CESifo Group Munich.

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