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

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  • Arnoud W.A. Boot

    ()
    (Faculty of Economics & Econometrics, Universiteit van Amsterdam)

  • Matej Marinc

    ()
    (University of Ljubljana)

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 Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 06-015/2.

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Date of creation: 27 Jan 2006
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Handle: RePEc:dgr:uvatin:20060015

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Web page: http://www.tinbergen.nl

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Keywords: Banking; Capital regulation; Competition;

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References

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  1. 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.
  2. Douglas W. Diamond & Raghuram G. Rajan, 1999. "A Theory of Bank Capital," NBER Working Papers 7431, National Bureau of Economic Research, Inc.
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  6. Stiroh, Kevin J & Strahan, Philip E, 2003. " Competitive Dynamics of Deregulation: Evidence from U.S. Banking," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(5), pages 801-28, October.
  7. Holmström, Bengt & Tirole, Jean, 1994. "Financial Intermediation, Loanable Funds and the Real Sector," IDEI Working Papers 40, Institut d'Économie Industrielle (IDEI), Toulouse.
  8. 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.
  9. 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.
  10. Repullo, Rafael, 2004. "Capital requirements, market power, and risk-taking in banking," Journal of Financial Intermediation, Elsevier, vol. 13(2), pages 156-182, April.
  11. Lucy White & Alan D. Morrison, 2002. "Crises and Capital Requirements in Banking," OFRC Working Papers Series 2002fe05, Oxford Financial Research Centre.
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  13. 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.
  14. Xavier Vives, 2001. "Competition in the Changing World of Banking," Oxford Review of Economic Policy, Oxford University Press, vol. 17(4), pages 535-547.
  15. Ongena, S. & Smith, D.C., 2000. "Bank relationships: A review," Open Access publications from Tilburg University urn:nbn:nl:ui:12-80678, Tilburg University.
  16. Allen N. Berger & Rebecca S. Demsetz & Philip E. Strahan, 1998. "The consolidation of the financial services industry: causes, consequences, and implications for the future," Finance and Economics Discussion Series 1998-46, Board of Governors of the Federal Reserve System (U.S.).
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  18. Shaked, Avner & Sutton, John, 1982. "Relaxing Price Competition through Product Differentiation," Review of Economic Studies, Wiley Blackwell, vol. 49(1), pages 3-13, January.
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Citations

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Cited by:
  1. Maria Lehner & Monika Schnitzer, 2006. "Entry of Foreign Banks and their Impact on Host Countries," Working Papers 002, Bavarian Graduate Program in Economics (BGPE).
  2. Claudia M. Buch & Gayle L. DeLong, 2008. "Banking Globalization: International Consolidation and Mergers in Banking," IAW Discussion Papers 38, Institut für Angewandte Wirtschaftsforschung (IAW).
  3. repec:hal:cepnwp: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. VanHoose, David, 2007. "Theories of bank behavior under capital regulation," Journal of Banking & Finance, Elsevier, vol. 31(12), pages 3680-3697, December.
  6. 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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