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

European Banking Center Discussion Paper No. 2010-19S

CentER Discussion Paper Series No. 2010-67S

31 Pages Posted: 7 Jul 2010

See all articles by Gianni De Nicolo

Gianni De Nicolo

Johns Hopkins University - Carey Business School; CESifo (Center for Economic Studies and Ifo Institute)

Marcella Lucchetta

Ca Foscari University of Venice

Multiple version iconThere are 3 versions of this paper

Date Written: May 31, 2009

Abstract

We study a simple general equilibrium model in which investment in a risky technology is subject to moral hazard and banks can extract market power rents. We show that 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. Importantly, they 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.

Keywords: General Equilibrium, Bank Competition, Market Power Rents, Risk

JEL Classification: D5, G21

Suggested Citation

De Nicolo, Gianni and Lucchetta, Marcella, Financial Intermediation, Competition, and Risk: A General Equilibrium Exposition (May 31, 2009). European Banking Center Discussion Paper No. 2010-19S, CentER Discussion Paper Series No. 2010-67S, Available at SSRN: https://ssrn.com/abstract=1635244 or http://dx.doi.org/10.2139/ssrn.1635244

Gianni De Nicolo (Contact Author)

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States
(410) 234-4507 (Phone)

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

Marcella Lucchetta

Ca Foscari University of Venice ( email )

Venice
Italy

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