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On the Coexistence of Banks and Markets

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  • Hans Gersbach
  • Harald Uhlig

Abstract

We examine the coexistence of banks and financial markets, studying a credit market where the qualities of investment projects are not observable and the investment decisions of entrepreneurs are not contractible. Standard banks can alleviate moral-hazard problems by securing a portion of a repayment in the case of non-investment. Financial markets operated by investment banks and rating agencies have screening know-how and can alleviate adverse-selection problems. In competition, standard banks are forced to increase repayments, since financial markets can attract the highest-quality borrowers. This, in turn, increases the share of shirkers and may make lending unprofitable for standard banks. The coexistence of financial markets and standard banks is socially inefficient. The same inefficiency can happen with the entrance of sophisticated banks, operating with a combination of rating and ongoing monitoring technologies.

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Bibliographic Info

Paper provided by Sonderforschungsbereich 649, Humboldt University, Berlin, Germany in its series SFB 649 Discussion Papers with number SFB649DP2006-054.

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Length: 34 pages
Date of creation: Mar 2006
Date of revision:
Handle: RePEc:hum:wpaper:sfb649dp2006-054

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Keywords: contract; debt contract; adverse selection; moral hazard; coexistence of financial intermediaries; regulation;

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Cited by:
  1. Solomon, Bernard-Daniel, 2008. "Banks as Better Monitors and Firms' Financing Choices in Dynamic General Equilibrium," MPRA Paper 23958, University Library of Munich, Germany, revised 01 Jun 2010.

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