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Bank Solvency, Market Structure, and Monitoring Incentives

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  • Caminal, Ramón
  • Matutes, Carmen

Abstract

We analyse the impact of market structure on the probability of banking failure when banks’ loan portfolios are subject to aggregate uncertainty. In our model borrowers are subject to a moral hazard problem, which induces banks to choose between two second-best alternative devices: costly monitoring and credit rationing. We show that investment depends on both the lending rate and the information structure. Since monitoring incentives increase with interest rate margins, the relationship between market structure and investment is ambiguous. Also, larger investment levels imply that the expected return of marginal projects is lower and thus banks’ portfolios are more vulnerable to aggregate uncertainty. Consequently, a monopoly bank monitors borrowers more intensively, rations the amount of credit less frequently and hence may go bankrupt with higher probability than competitive banks.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 1665.

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Date of creation: Jun 1997
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Handle: RePEc:cpr:ceprdp:1665

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Related research

Keywords: Banking Competition; Bankruptcy; Credit Constraint; Monitoring; Moral Hazard;

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Cited by:
  1. Daniel Covitz & Erik Heitfield, 1999. "Monitoring, moral hazard, and market power: a model of bank lending," Finance and Economics Discussion Series 1999-37, Board of Governors of the Federal Reserve System (U.S.).
  2. Schnitzer, Monika, 1998. "On the Role of Bank Competition for Corporate Finance and Corporate Control in Transition Economies," CEPR Discussion Papers 2013, C.E.P.R. Discussion Papers.
  3. Claudia M. Buch, 2000. "Capital Market Integration in Euroland: The Role of Banks," German Economic Review, Verein für Socialpolitik, vol. 1(4), pages 443-464, November.

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