Optimal Capacity in the Banking Sector and Economic Growth

Abstract

The paper investigates, from the welfare and growth point of view, the determination of the optimal capacity of the banking system. For that purpose, we consider an overlapping generation model with endogenous growth. There is horizontal differentiation and imperfect competition in the banking sector. Macroeconomic shocks affect the return on capital and, together with the expectations of depositors, condition the stability of the banking sector. We specify to what extent deposit insurance may reduce instability and increase the number of deposits, welfare and growth. We also characterize the conditions under which excess banking capacities may appear and how their reduction may improve welfare.

Keywords: Deposit insurance, imperfect competition, growth, banking

JEL Classification: 016, G21