A Model of Competition in Banking: Bank Capital vs Expertise |
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| Institution: | 1. Lumsa University, Rome;2. Michigan State University, Department of Economics, Marshall-Adams Hall, 486 W Circle Dr. Rm 110, East Lansing, MI 48824, USA;3. Luiss University, Rome;1. Massachusetts Institute of Technology and Carnegie-Mellon University, 50 Memorial Drive, Cambridge, MA 02142, USA;2. University of Pennsylvania and NBER, 3718 Locust Walk, 428 McNeil Building, Philadelphia, PA 19104, USA;1. Institute of Corporate Finance, Humboldt University, Berlin, Germany;2. E.CA Economics, Berlin, Germany |
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| Abstract: | This paper presents a model of competition in the banking industry based upon the interplay of two factors: the level of capitalization of banks and their ability to monitor different types of projects (i.e., their expertise). In a setting of moral hazard with limited liability, banks must receive some rents to induce them to monitor projects diligently. The rents are decreasing in the banks' expertise and in the amount of capital that banks are able to commit to a project. This leads to a trade-off between capital and expertise. The analysis shows how shocks to bank capital and interest rates, and technological shocks can affect competition and monitoring efficiency in the banking sector. Journal of Economic Literature Classification Numbers: G21, G32. |
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