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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. 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.
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  4. Xavier Freixas & Sjaak Hurkens & Alan D. Morrison & Nir Vulkan, 2005. "Interbank Competition with Costly Screening," OFRC Working Papers Series 2005fe02, Oxford Financial Research Centre.
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Cited by:
  1. repec:hal:cepnwp:halshs-00424214 is not listed on IDEAS
  2. VanHoose, David, 2007. "Theories of bank behavior under capital regulation," Journal of Banking & Finance, Elsevier, vol. 31(12), pages 3680-3697, December.
  3. Lehner, Maria & Schnitzer, Monika, 2006. "Entry of Foreign Banks and their Impact on Host Countries," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 152, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
  4. Radu Vranceanu & Damien Besancenot, 2010. "Banks' risk race: A signaling explanation," Post-Print hal-00554719, HAL.
  5. Eric Van Tassel, 2009. "Sharing credit information under endogenous costs," Working Papers 09004, Department of Economics, College of Business, Florida Atlantic University.

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