Financial Intermediation, Competition, and Risk: A General Equilibrium Exposition

May 1, 2009

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Format: Chicago

Gianni De Nicolo, and Marcella Lucchetta. Financial Intermediation, Competition, and Risk: A General Equilibrium Exposition, (USA: International Monetary Fund, 2009) accessed September 20, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

We study a simple general equilibrium model in which investment in a risky technology is subject to moral hazard and banks can extract market power rents. We show that more bank competition results in lower economy-wide risk, lower bank capital ratios, more efficient production plans and Pareto-ranked real allocations. Perfect competition supports a second best allocation and optimal levels of bank risk and capitalization. These results are at variance with those obtained by a large literature that has studied a similar environment in partial equilibrium. Importantly, they are empirically relevant, and demonstrate the need of general equilibrium modeling to design financial policies aimed at attaining socially optimal levels of systemic risk in the economy.

Subject: Banking, Competition, General equilibrium models, Moral hazard, Self-employment

Keywords: Bank, Market power rent, WP

Publication Details

Pages:

29
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2009/105
Stock No:

WPIEA2009105
ISBN:

9781451872521
ISSN:

1018-5941

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