If Financial Market Competition is so Intense, Why are Financial Firm Profits so High? Reflections on the Current ‘Golden Age’ of Finance
AbstractIn 1997 former Federal Reserve Board Chairman Paul Volcker posed a question about the commercial banking system he said he could not answer. The industry was under more intense competitive pressure than at any time in living memory, Volcker noted, “yet at the same time the industry never has been so profitable.”�In this paper, Crotty�refers to the seemingly strange coexistence of intense competition and historically high profit rates in commercial banking as Volcker’s Paradox. He extends the paradox to all important financial institutions and discusses four developments that together help resolve it: rapid growth in the demand for financial products and services in the past quarter century; rising concentration in most major financial industries; increased risk-taking among all the major financial market actors that has raised average profit rates; and rapid financial innovation in over-the-counter derivatives that allows giant banks to create and trade complex products with high profit margins. The last section of the paper discusses the role of moral hazard in today’s financial markets. Has the conventional belief that financial investment strategies that were formerly considered too risky have been made safe (and profitable) by modern risk-management techniques increased the likelihood of a future systemic financial crisis?
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Bibliographic InfoPaper provided by Political Economy Research Institute, University of Massachusetts at Amherst in its series Working Papers with number wp134.
Date of creation: 2007
Date of revision:
financial markets; financial profits; competition; financial strategies; systemic financial crises;
Find related papers by JEL classification:
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- G2 - Financial Economics - - Financial Institutions and Services
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
- L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance
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