Bank regulation and market structure |
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| Institution: | 1. Dipartimento di Economia e Finanza, Catholic University of Milan, Via Necchi 5, 20123 Milano, Italy;2. Dipartimento di Matematica per le Scienze Economiche, Finanziarie ed Attuariali, Catholic University of Milan, Largo Gemelli 1, Milano 20123, Italy;1. Oslo Business School, Oslo Metropolitan University, Norway;2. Department of Economics, University of Oslo, Norway;1. Office of Communications UK;2. Dipartimento di Scienze Economiche ed Aziendali “M. Fanno”, Università di Padova, Italy;3. School of Economics and Centre for Competition Policy, University of East Anglia, UK;1. Department of Economics and IGIER, Bocconi University, Via Roentgen 1, 20136 Milano, Italy.;2. Department of Economics, Indiana University, 100 S Woodlawn Ave, Bloomington, IN 47405, USA.;1. Ohio State University, 1945 N High St, Columbus, OH 43210, USA;2. State University of New York (SUNY) at Albany, Hudson 257A, Albany, New York, 12222, USA;1. Federal Trade Commission United States;2. Federal Reserve Board United States |
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| Abstract: | In our model, banks, heterogeneous in terms of entry costs, compete à la Salop for depositors on the unit circle. When capital requirements, intended to prevent risk shifting, are increased, the resulting costs are passed on to depositors in the form of reduced deposit rates or quality of service. This may induce depositors to migrate to unregulated shadow banks, the consequence being a change in the market structure for regulated banks: for low levels of capital requirements we observe monopolistic competition, while for higher levels constrained oligopoly and, finally, local monopoly. Under the latter two types of market structure, higher capital requirements reduce the profit margins and franchise values of banks, which may have the unintended effect of inducing banks to increase the riskiness of their investments. |
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