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

_IMF Working Papers, May 1, 2009_

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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

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### 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*

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/31/financial-intermediation-competition-and-risk-a-general-equilibrium-exposition-22931_