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Banks, markets, and efficiency

  • Falko Fecht


  • Antoine Martin


In this paper, we address the question whether increasing households' financial market access improves welfare in a financial system in which there is intense competition among banks for private households' funds. Following earlier work by Diamond and by Fecht, we use a model in which the degree of liquidity insurance offered to households through banks' deposit contracts is restrained by households' financial market access. However, we also assume spatial monopolistic competition among banks. Because monopoly rents are assumed to bring about inefficiencies, improved financial market access that limits monopoly rents also entails a positive effect; however, this beneficial effect is only relevant if competition among banks does not sufficiently restrain monopoly rents already. ; Thus, our results suggest that in Germany's bank-dominated financial system, which is characterized by intense competition for households' deposits, improved financial market access might reduce welfare because it only reduces risk sharing. In contrast, in the U.S. banking system, where there is less competition for households' deposits, a high level of household financial market participation might be beneficial.

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Article provided by Springer in its journal Annals of Finance.

Volume (Year): 5 (2009)
Issue (Month): 2 (March)
Pages: 131-160

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Handle: RePEc:kap:annfin:v:5:y:2009:i:2:p:131-160
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  1. Falko Fecht & Kevin Huang, 2004. "Financial intermediaries, markets, and growth," Econometric Society 2004 North American Summer Meetings 419, Econometric Society.
  2. Skeie, David R., 2008. "Banking with nominal deposits and inside money," Journal of Financial Intermediation, Elsevier, vol. 17(4), pages 562-584, October.
  3. Harris, Milton & Raviv, Artur, 1990. " Capital Structure and the Informational Role of Debt," Journal of Finance, American Finance Association, vol. 45(2), pages 321-49, June.
  4. Antoine Martin, 2001. "Liquidity provision vs. deposit insurance : preventing bank panics without moral hazard?," Research Working Paper RWP 01-05, Federal Reserve Bank of Kansas City.
  5. Douglas W. Diamond & Raghuram G. Rajan, 2001. "Liquidity Risk, Liquidity Creation, and Financial Fragility: A Theory of Banking," Journal of Political Economy, University of Chicago Press, vol. 109(2), pages 287-327, April.
  6. Diamond, Douglas W & Dybvig, Philip H, 1983. "Bank Runs, Deposit Insurance, and Liquidity," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 401-19, June.
  7. Ernst-Ludwig VON THADDEN, 1998. "Liquidity Creation through Banks and Markets : Multiple Insurance and Limited Market Access," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 9820, Université de Lausanne, Faculté des HEC, DEEP.
  8. Carletti, Elena & Hartmann, Philipp & Spagnolo, Giancarlo, 2004. "Bank Mergers, Competition and Liquidity," CEPR Discussion Papers 4260, C.E.P.R. Discussion Papers.
  9. Hamerle, Alfred & Liebig, Thilo & Scheule, Harald, 2004. "Forecasting Credit Portfolio Risk," Discussion Paper Series 2: Banking and Financial Studies 2004,01, Deutsche Bundesbank, Research Centre.
  10. Douglas W. Diamond, . "Liquidity, Banks and Markets," CRSP working papers 326, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  11. von Thadden, Ernst-Ludwig, 1997. "The term-structure of investment and the banks' insurance function," European Economic Review, Elsevier, vol. 41(7), pages 1355-1374, July.
  12. Erland Nier & Celine Gondat-Larralde, 2004. "The Microeconomics Of Retail Banking - An Empirical Analysis Of The UK Market For Personal Current Accounts," Royal Economic Society Annual Conference 2004 110, Royal Economic Society.
  13. Falko Fecht, 2003. "On the Stability of Different Financial Systems," Finance 0305008, EconWPA.
  14. Elizabeth Kiser, 2002. "Predicting Household Switching Behavior and Switching Costs at Depository Institutions," Review of Industrial Organization, Springer, vol. 20(4), pages 349-365, June.
  15. Aghion, Philippe & Bolton, Patrick, 1992. "An Incomplete Contracts Approach to Financial Contracting," Review of Economic Studies, Wiley Blackwell, vol. 59(3), pages 473-94, July.
  16. Ernst-Ludwig VON THADDEN, 1996. "Optimal Liquidity Provision and Dynamic Incentive Compatibility," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 9604, Université de Lausanne, Faculté des HEC, DEEP.
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