Bank Competition and Credit Booms

40 Pages Posted: 13 Feb 2015

See all articles by Phurichai Rungcharoenkitkul

Phurichai Rungcharoenkitkul

Bank for International Settlements (BIS) - Monetary and Economic Department

Date Written: February 2015

Abstract

A model of imperfectly competitive banks is examined under asymmetric information about borrower quality. Greater bank competition and a lower risk-free rate raise the screening costs of lending, which can result in pooling Nash equilibria with credit booms. Such equilibria are characterised by sharp increases in credit supply and deteriorations in average loan quality, which are inefficient for banks. In the model, banks' incentives to make risky loans can vary despite unchanged capital structure, thus highlighting the role of a risk-taking mechanism. This approach helps explain the existing mixed empirical results on the relationship between bank competition and financial stability. The model can be used to define a neutral interest rate in the context of financial cycles, namely a finance-neutral interest rate, which is estimated in the case of the United States.

Keywords: bank competition, credit booms, asymmetric information, optimal contract, coordination failure, finance-neutral rate of interest, monetary policy

JEL Classification: G21, D82, D86, E51, E52

Suggested Citation

Rungcharoenkitkul, Phurichai, Bank Competition and Credit Booms (February 2015). BIS Working Paper No. 488, Available at SSRN: https://ssrn.com/abstract=2564258

Phurichai Rungcharoenkitkul (Contact Author)

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

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