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Imperfect Banking Competition and the Propagation of Uncertainty Shocks

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  • Tommaso Gasparini

Abstract

Uncertainty shocks, by propagating through the banking sector, play a crucial role in driving business cycle fluctuations. To examine how the recent decline in U.S. banking competition has affected the transmission of these shocks, I develop a dynamic stochastic general equilibrium model featuring heterogeneous banks, imperfect banking competition and financial frictions. The model shows that reduced competition in the banking sector leads to higher borrowing rates and increased risk-taking by borrowers. As a result, uncertainty shocks generate more pronounced increases in defaults and sharper contractions in investment and output in less competitive banking environments. Quantitatively, the model implies that the recent decline in U.S. banking competition results in a 0.1 percentage points larger drop in GDP one year after an uncertainty shock. This finding is supported by panel local projection evidence indicating that lower banking competition amplifies the negative impact of uncertainty on GDP.

Suggested Citation

  • Tommaso Gasparini, 2025. "Imperfect Banking Competition and the Propagation of Uncertainty Shocks," Working papers 997, Banque de France.
    • Handle: RePEc:bfr:banfra:997
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    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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