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

Author/Editor: De Nicoló, Gianni | Lucchetta, Marcella
Authorized for Distribution: May 1, 2009
Electronic Access: Free Full Text (PDF file size is 597KB)
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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.
 
Series: Working Paper No. 09/105
Subject(s): Banking sector | Banks | Borrowing | Capital | Competition | Corporate sector | Economic models | Financial intermediation | Financial risk | Investment | Risk management
Author's keyword(s): General Equilibrium | Bank Competition | Market Power Rents | Risk
 
English  
    Published:   May 1, 2009        
            Format:   Paper
    Stock No:   WPIEA2009105   Pages:   29
    Price:   US$18.00 (Academic Rate: US$18.00 )
       
     
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