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Banking competition, monitoring incentives and financial stability

  • VO Thi Quynh Anh

    ()

    (Norges Bank (Central Bank of Norway))

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    This paper addresses the desirability of competition in banking industry. In a model where banks compete on both deposit and loan markets and where banks can use monitoring technology to control entrepreneurs' behavior, we investigate three questions: what are the effects of competition on banks' monitoring incentives? Does competition hurt banks' stability? What can be devices to correct potential negative effcts of competition vis à vis financial stability? We find that impacts of competition on banks' monitoring incentives can be decomposed into two effects: one on the attractiveness of monitoring and the other on the monitoring efficiency. The first effect operates through the link between competition and loan margin. The second effect comes from the fact that marginal effct of monitoring on entrepreneur's effort depends on loan rate. We characterize the sufficient condition under which competition will increase monitoring incentives as well as banks' stability. For the third question, we focus on the role of capital requirement and claim that with capital requirement, we can attain a weak correction but not strong correction.

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    File URL: http://www.norges-bank.no/en/Published/Papers/Working-Papers/2010/WP-201016/
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    Paper provided by Norges Bank in its series Working Paper with number 2010/16.

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    Length: 20 pages
    Date of creation: 31 Aug 2010
    Date of revision:
    Handle: RePEc:bno:worpap:2010_16
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    1. Caminal, Ramon & Matutes, Carmen, 2002. "Market power and banking failures," International Journal of Industrial Organization, Elsevier, vol. 20(9), pages 1341-1361, November.
    2. Isik, Ihsan & Kabir Hassan, M., 2003. "Financial deregulation and total factor productivity change: An empirical study of Turkish commercial banks," Journal of Banking & Finance, Elsevier, vol. 27(8), pages 1455-1485, August.
    3. Stephen Nickell, 1993. "Competition and Corporate Performance," CEP Discussion Papers dp0182, Centre for Economic Performance, LSE.
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    9. Martinez-Miera, David & Repullo, Rafael, 2008. "Does Competition Reduce the Risk of Bank Failure?," CEPR Discussion Papers 6669, C.E.P.R. Discussion Papers.
    10. Martin Cihák & Simon Wolfe & Klaus Schaeck, 2006. "Are More Competitive Banking Systems More Stable?," IMF Working Papers 06/143, International Monetary Fund.
    11. Bhattacharyya, Arunava & Lovell, C. A. K. & Sahay, Pankaj, 1997. "The impact of liberalization on the productive efficiency of Indian commercial banks," European Journal of Operational Research, Elsevier, vol. 98(2), pages 332-345, April.
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    14. Matutes, Carmen & Vives, Xavier, 2000. "Imperfect competition, risk taking, and regulation in banking," European Economic Review, Elsevier, vol. 44(1), pages 1-34, January.
    15. Gianni De Nicoló & Abu M. Jalal & John H. Boyd, 2006. "Bank Risk-Taking and Competition Revisited; New Theory and New Evidence," IMF Working Papers 06/297, International Monetary Fund.
    16. Broecker, Thorsten, 1990. "Credit-Worthiness Tests and Interbank Competition," Econometrica, Econometric Society, vol. 58(2), pages 429-52, March.
    17. John H. Boyd & Gianni De Nicolã, 2005. "The Theory of Bank Risk Taking and Competition Revisited," Journal of Finance, American Finance Association, vol. 60(3), pages 1329-1343, 06.
    18. Kevin C. Murdock & Thomas F. Hellmann & Joseph E. Stiglitz, 2000. "Liberalization, Moral Hazard in Banking, and Prudential Regulation: Are Capital Requirements Enough?," American Economic Review, American Economic Association, vol. 90(1), pages 147-165, March.
    19. Xavier Vives, 2001. "Competition in the Changing World of Banking," Oxford Review of Economic Policy, Oxford University Press, vol. 17(4), pages 535-547.
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