## Bank Competition and Financial Stability: A General Equilibrium Exposition

_IMF Working Papers, December 1, 2011_

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## Bibliographic details
- Authors: Marcella Lucchetta, Gianni De Nicolo
- Published: December 1, 2011
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781463927295.001

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### Summary
- Study of versions of a general equilibrium banking model with moral hazard under either constant or increasing returns to scale of the intermediation technology used by banks to screen and/or monitor borrowers.
- Key comparative result:
  - If the intermediation technology exhibits increasing returns to scale, or it is relatively efficient, then perfect competition is optimal and supports the lowest feasible level of bank risk.
  - If the intermediation technology exhibits constant returns to scale, or is relatively inefficient, then imperfect competition and intermediate levels of bank risks are optimal.
- Results are stated to be empirically relevant and to carry significant implications for financial policy.

### Main findings and analysis
- Model framework:
  - General equilibrium banking model with moral hazard.
  - Focus on returns to scale of intermediation technology used for screening and/or monitoring borrowers.
- Comparative outcomes by technology type:
  - Increasing returns to scale (or relatively efficient technology):
    - Perfect competition is optimal.
    - Supports the lowest feasible level of bank risk.
  - Constant returns to scale (or relatively inefficient technology):
    - Imperfect competition is optimal.
    - Supports intermediate levels of bank risks.
- Emphasis on empirical relevance and policy implications derived from the model results.

### Policy implications and recommendations
- Policy should account for the returns-to-scale properties and relative efficiency of intermediation technology when assessing competition policy and financial stability trade-offs.
- When intermediation technology exhibits increasing returns to scale or is relatively efficient:
  - Policies that promote competition (toward perfect competition) can be welfare-enhancing and reduce bank risk.
- When intermediation technology exhibits constant returns to scale or is relatively inefficient:
  - Some degree of imperfect competition may be optimal and could entail accepting intermediate levels of bank risk.

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/31/bank-competition-and-financial-stability-a-general-equilibrium-exposition-25439_