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Bank Solvency, Market Structure, and Monitoring Incentives

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  • Caminal, Ramon
  • Matutes, Carmen

Abstract

We analyse the impact of market structure on the probability of banking failure when banks’ loan portfolios are subject to aggregate uncertainty. In our model borrowers are subject to a moral hazard problem, which induces banks to choose between two second-best alternative devices: costly monitoring and credit rationing. We show that investment depends on both the lending rate and the information structure. Since monitoring incentives increase with interest rate margins, the relationship between market structure and investment is ambiguous. Also, larger investment levels imply that the expected return of marginal projects is lower and thus banks’ portfolios are more vulnerable to aggregate uncertainty. Consequently, a monopoly bank monitors borrowers more intensively, rations the amount of credit less frequently and hence may go bankrupt with higher probability than competitive banks.

Suggested Citation

  • Caminal, Ramon & Matutes, Carmen, 1997. "Bank Solvency, Market Structure, and Monitoring Incentives," CEPR Discussion Papers 1665, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:1665
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    Citations

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    Cited by:

    1. Monika Schnitzer, 1999. "On the Role of Bank Competition for Corporate Finance and Corporate Control in Transition Economies," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 155(1), pages 1-22, March.
    2. Claudia M. Buch, 2000. "Capital Market Integration in Euroland: The Role of Banks," German Economic Review, Verein für Socialpolitik, vol. 1(4), pages 443-464, November.
    3. Daniel M. Covitz & Erik Heitfield, 1999. "Monitoring, moral hazard, and market power: a model of bank lending," Finance and Economics Discussion Series 1999-37, Board of Governors of the Federal Reserve System (U.S.).

    More about this item

    Keywords

    Banking Competition; Bankruptcy; Credit Constraint; Monitoring; Moral Hazard;

    JEL classification:

    • D4 - Microeconomics - - Market Structure, Pricing, and Design
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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