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The Social Cost of a Credit Monopoly

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  • Andreas Madestam

Abstract

Banks provide credit and take deposits. Whereas a high price in the credit market increases banks’ retained earnings and attracts more deposits, it reduces lending if borrowers are sufficiently poor to be tempted by diversion. Thus optimal bank market structure trades off the benefits of monopoly banking in attracting deposits against losses due to tighter credit. The model shows that market structure is irrelevant if both banks and borrowers lack resources. Monopoly banking induces tighter credit rationing if borrowers are poor and banks are wealthy, and increases lending if borrowers are wealthy and banks lack resources. The results indicate that improved legal protection of creditors is a more efficient policy choice than legal protection of depositors, and that subsidies to firms lead to better outcomes than subsidies to banks. There are also likely to be sizable gains from promoting bank competition in developing countries.

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Paper provided by IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University in its series Working Papers with number 422.

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Date of creation: 2011
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Handle: RePEc:igi:igierp:422

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  1. Mike Burkart & Tore Ellingsen, 2002. "In-kind finance," LSE Research Online Documents on Economics 24940, London School of Economics and Political Science, LSE Library.
  2. David M. Kreps & Jose A. Scheinkman, 1983. "Quantity Precommitment and Bertrand Competition Yield Cournot Outcomes," Bell Journal of Economics, The RAND Corporation, vol. 14(2), pages 326-337, Autumn.
  3. Gelos, R. Gaston & Werner, Alejandro M., 2002. "Financial liberalization, credit constraints, and collateral: investment in the Mexican manufacturing sector," Journal of Development Economics, Elsevier, vol. 67(1), pages 1-27, February.
  4. Nicola Cetorelli, 1997. "The role of credit market competition on lending strategies and on capital accumulation," Working Paper Series, Issues in Financial Regulation WP-97-14, Federal Reserve Bank of Chicago.
  5. Mathias Dewatripont & Jean Tirole, 1994. "The prudential regulation of banks," ULB Institutional Repository 2013/9539, ULB -- Universite Libre de Bruxelles.
  6. Robert Marquez, 2002. "Competition, Adverse Selection, and Information Dispersion in the Banking Industry," Review of Financial Studies, Society for Financial Studies, vol. 15(3), pages 901-926.
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