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Financial Intermediation, Competition, and Risk: A General Equilibrium Exposition

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Author Info

  • Di Nicolo, G.
  • Lucchetta, M.

    (Tilburg University, Center for Economic Research)

Abstract

We study a simple general equilibrium model in which investment in a risky technology is subject to moral hazard and banks can extract market power rents. We show that more bank competition results in lower economy-wide risk, lower bank capital ratios, more efficient production plans and Pareto-ranked real allocations. Perfect competition supports a second best allocation and optimal levels of bank risk and capitalization. These results are at variance with those obtained by a large literature that has studied a similar environment in partial equilibrium. Importantly, they are empirically relevant, and demonstrate the need of general equilibrium modeling to design financial policies aimed at attaining socially optimal levels of systemic risk in the economy.

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Bibliographic Info

Paper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number 2010-67S.

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Date of creation: 2010
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Handle: RePEc:dgr:kubcen:201067s

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Web page: http://center.uvt.nl

Related research

Keywords: General Equilibrium; Bank Competition; Market Power Rents; Risk;

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References

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  1. Nicola Cetorelli & Philip Strahan, 2004. "Finance as a barrier to entry: bank competition and industry structure in local U.S. markets," Working Paper Series WP-04-04, Federal Reserve Bank of Chicago.
  2. Nicola Cetorelli & Michele Gambera, 1999. "Banking Market Structure, Financial Dependence and Growth: International Evidence from Industry Data," Center for Financial Institutions Working Papers 00-19, Wharton School Center for Financial Institutions, University of Pennsylvania.
  3. Matutes, Carmen & Vives, Xavier, 1996. "Competition for Deposits, Fragility, and Insurance," Journal of Financial Intermediation, Elsevier, vol. 5(2), pages 184-216, April.
  4. Elena Loukoianova & Gianni De Nicoló & John H. Boyd, 2009. "Banking Crises and Crisis Dating," IMF Working Papers 09/141, International Monetary Fund.
  5. Gianni De Nicoló & Elena Loukoianova, 2007. "Bank Ownership, Market Structure and Risk," IMF Working Papers 07/215, International Monetary Fund.
  6. Cordella, Tito & Levy Yeyati, Eduardo, 1998. "Financial Opening, Deposit Insurance and Risk in a Model of Banking Competition," CEPR Discussion Papers 1939, C.E.P.R. Discussion Papers.
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Cited by:
  1. Douglas Gale, 2010. "The Effects of Bank Capital on Lending: What Do We Know, and What Does It Mean?," International Journal of Central Banking, International Journal of Central Banking, vol. 6(34), pages 187-204, December.
  2. John Boyd & Gianni De Nicolò & Elena Loukoianova, 2010. "Banking Crises and Crisis Dating: Theory and Evidence," CESifo Working Paper Series 3134, CESifo Group Munich.
  3. Samantas, Ioannis, 2013. "Bank competition and financial (in)stability in Europe: A sensitivity analysis," MPRA Paper 51621, University Library of Munich, Germany.

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