Market power and banking failures |
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| Institution: | 1. Department of Finance and Banking, Faculty of Business and Accountancy, University of Malaya, Malaysia;2. Department of Business Administration, Faculty of Business Studies, International Islamic University Chittagong, Bangladesh;3. Department of Accountancy, Faculty of Business and Accountancy, University of Malaya, Malaysia;1. Cass Business School, City University London, United Kingdom\n;2. Nanyang Business School, Nanyang Technological University, Singapore\n;3. Faculty of Business and Economics, University of Hong Kong, Hong Kong\n;4. CEPR, United Kingdom\n |
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| Abstract: | We investigate whether more competition in the banking industry necessarily results in a higher probability of banking failures, as it is often suggested. In our model borrowers face a moral hazard problem, which induces banks to choose between costly monitoring and credit rationing. We show that investment decreases with the lending rate and increases with monitoring effort. Since incentives to monitor are enhanced by market power, the relationship between market structure and investment is ambiguous. In the presence of non-diversifiable risk and decreasing returns to scale, more investment implies higher failure rates. As a result, the relationship between market power and banking failures is ambiguous. |
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