Banks, Markets, and Efficiency
35 Pages Posted: 25 Jan 2005
There are 2 versions of this paper
Banks, Markets, and Efficiency
Banks, Markets, and Efficiency
Date Written: January 19, 2005
Abstract
Following Diamond (1997) we use a model in which financial market access of households restrains the efficiency of the liquidity insurance that banks' deposit contracts provide to households that are subject to idiosyncratic liquidity shocks. But in contrast to these approaches we assume spatial monopolistic competition among banks. Since monopoly rents are assumed to bring about inefficiencies, improved financial market access that limits monopoly rents also entails a positive effect. But this beneficial effect is only relevant if competition among banks does not sufficiently restrain monopoly rents already.
Thus, our results suggest that in the bank-dominated financial system of Germany, in which banks intensely compete for households' deposits, improved financial market access might reduce welfare because it only reduces risk sharing. In contrast, in the banking system of the U.S., with less competition for households' deposits, a high level of households' financial market participation might be beneficial.
Keywords: Banking competition, deposit contracts, efficiency, risk sharing
JEL Classification: G21, D61, D82
Suggested Citation: Suggested Citation
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