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Competition and Entry in Banking: Implications for Stability and Capital Regulation

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  • Boot, Arnoud W A
  • Marinc, Matej

Abstract

We assess the influence of competition and capital regulation on the stability of the banking system. We particularly ask two questions: i) how does capital regulation affect (endogenous) entry; and ii) how do (exogenous) changes in the competitive environment affect bank monitoring choices and the effectiveness of capital regulation? Our approach deviates from the extant literature in that it recognizes the fixed costs associated with banks’ monitoring technologies. These costs make market share and scale important for the banks’ cost structures. Our most striking result is that increasing (costly) capital requirements can lead to more entry into banking, essentially by reducing the competitive strength of lower quality banks. We also show that competition improves the monitoring incentives of better quality banks and deteriorates the incentives of lower quality banks; and that precisely for those lower quality banks competition typically compromises the effectiveness of capital requirements. We generalize the analysis along a few dimensions, including an analysis of the effects of asymmetric competition, e.g. one country that opens up its banking system for competitors but not vice versa.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5518.

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Date of creation: Feb 2006
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Handle: RePEc:cpr:ceprdp:5518

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Keywords: banking; capital regulation; competition;

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References

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  1. 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.
  2. Xavier Freixas & Sjaak Hurkens & Alan D. Morrison & Nir Vulkan, 2004. "Interbank comptetition with costly screening," Economics Working Papers 802, Department of Economics and Business, Universitat Pompeu Fabra.
  3. Repullo, Rafael, 2004. "Capital requirements, market power, and risk-taking in banking," Journal of Financial Intermediation, Elsevier, Elsevier, vol. 13(2), pages 156-182, April.
  4. Allen, Franklin & Carletti, Elena & Marquez, Robert, 2005. "Credit market competition and capital regulation," CFS Working Paper Series 2005/23, Center for Financial Studies (CFS).
  5. Shaked, Avner & Sutton, John, 1982. "Relaxing Price Competition through Product Differentiation," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 49(1), pages 3-13, January.
  6. Boot, Arnoud W A & Thakor, Anjan, 1997. "Can Relationship Banking Survive Competition?," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1592, C.E.P.R. Discussion Papers.
  7. Thorsten Beck & Asli Demirguc-Kunt & Ross Levine, 2005. "Bank Concentration and Fragility: Impact and Mechanics," NBER Working Papers 11500, National Bureau of Economic Research, Inc.
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  9. Berger, Allen N. & Demsetz, Rebecca S. & Strahan, Philip E., 1999. "The consolidation of the financial services industry: Causes, consequences, and implications for the future," Journal of Banking & Finance, Elsevier, vol. 23(2-4), pages 135-194, February.
  10. Kopecky, Kenneth J. & VanHoose, David, 2006. "Capital regulation, heterogeneous monitoring costs, and aggregate loan quality," Journal of Banking & Finance, Elsevier, vol. 30(8), pages 2235-2255, August.
  11. Ongena, S. & Smith, D.C., 2000. "Bank relationships: A review," Open Access publications from Tilburg University urn:nbn:nl:ui:12-80678, Tilburg University.
  12. Xavier Vives, 2001. "Competition in the Changing World of Banking," Oxford Review of Economic Policy, Oxford University Press, vol. 17(4), pages 535-547.
  13. Douglas W. Diamond & Raghuram G. Rajan, . "A Theory of Bank Capital," CRSP working papers 363, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  14. Alan D. Morrison & Lucy White, 2005. "Crises and Capital Requirements in Banking," American Economic Review, American Economic Association, vol. 95(5), pages 1548-1572, December.
  15. Matutes, Carmen & Vives, Xavier, 1995. "Imperfect Competition, Risk Taking, and Regulation in Banking," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1177, C.E.P.R. Discussion Papers.
  16. 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.
  17. Kevin C. Murdock & Thomas F. Hellmann & Joseph E. Stiglitz, 2000. "Liberalization, Moral Hazard in Banking, and Prudential Regulation: Are Capital Requirements Enough?," American Economic Review, American Economic Association, vol. 90(1), pages 147-165, March.
  18. Fabio Panetta & Dario Focarelli, 2003. "Are Mergers Beneficial to Consumers? Evidence from the Italian Market for Bank Deposits," CEIS Research Paper 10, Tor Vergata University, CEIS.
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  20. Stiroh, Kevin J & Strahan, Philip E, 2003. " Competitive Dynamics of Deregulation: Evidence from U.S. Banking," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 35(5), pages 801-28, October.
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Citations

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Cited by:
  1. Lehner, Maria & Schnitzer, Monika, 2008. "Entry of foreign banks and their impact on host countries," Munich Reprints in Economics, University of Munich, Department of Economics 19238, University of Munich, Department of Economics.
  2. VanHoose, David, 2007. "Theories of bank behavior under capital regulation," Journal of Banking & Finance, Elsevier, vol. 31(12), pages 3680-3697, December.
  3. repec:hal:wpaper:halshs-00424214 is not listed on IDEAS
  4. Radu Vranceanu & Damien Besancenot, 2010. "Banks' risk race: A signaling explanation," Post-Print hal-00554719, HAL.
  5. Claudia M. Buch & Gayle L. DeLong, 2008. "Banking Globalization: International Consolidation and Mergers in Banking," IAW Discussion Papers, Institut für Angewandte Wirtschaftsforschung (IAW) 38, Institut für Angewandte Wirtschaftsforschung (IAW).
  6. Eric Van Tassel, 2009. "Sharing credit information under endogenous costs," Working Papers, Department of Economics, College of Business, Florida Atlantic University 09004, Department of Economics, College of Business, Florida Atlantic University.

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