Financial Intermediation, Competition, and Risk: A General Equilibrium Exposition
IMF Working Papers, May 1, 2009
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- Financial Intermediation, Competition, and Risk: A General Equilibrium Exposition
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Bibliographic details
- Authors: Gianni De Nicolo, Marcella Lucchetta
- Published: May 1, 2009
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451872521.001
Summary
- Study of a simple general equilibrium model in which investment in a risky technology is subject to moral hazard and banks can extract market power rents.
- Key result statements from the paper:
- 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.
- The results 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.
Model and scope
- Framework: simple general equilibrium model with:
- Risky technology investment subject to moral hazard.
- Banks able to extract market power rents.
- Comparison: contrasts general equilibrium outcomes with those from a large partial equilibrium literature that studied similar environments.
Major findings (enumerated)
- Competition and risk:
- More bank competition → lower economy-wide risk.
- More bank competition → lower bank capital ratios.
- More bank competition → more efficient production plans.
- More bank competition → Pareto-ranked real allocations.
- Market structure benchmark:
- Perfect competition supports a second best allocation.
- Perfect competition supports optimal levels of bank risk and capitalization.
- Literature contrast:
- Results differ from many partial equilibrium studies of similar settings.
- Empirical relevance:
- Findings are described as empirically relevant and indicate policy design implications.
Policy implications and recommendations
- Need for general equilibrium modeling:
- Design financial policies using general equilibrium frameworks to attain socially optimal levels of systemic risk in the economy.
- Regulatory focus:
- Consideration of how bank competition affects system-wide risk, capital ratios, and allocation efficiency when setting prudential and competition policies.
Keywords and subject classification
- Subject: Banking, Competition, General equilibrium models, Moral hazard, Self-employment
- Keywords: bank, market power rent, WP
Financial Intermediation, Competition, and Risk: A General Equilibrium Exposition — IMF Working Paper No. 2009/105