Interest Rates, Market Power, and Financial Stability

Rafael Repullo and David Martinez-Miera

No 15063, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This paper shows the relevance of market power to assess the effects of safe interest rates on financial intermediaries' risk-taking decisions. We consider an economy where (i) intermediaries have market power in granting loans, (ii) intermediaries monitor borrowers which lowers their probability of default, and (iii) monitoring is costly and unobservable which creates a moral hazard problem with uninsured depositors. We show that lower safe rates lead to lower intermediation margins and higher risk-taking when intermediaries have low market power, but the result reverses for high market power. We examine the robustness of this result to introducing non-monitored market finance, heterogeneity in monitoring costs, and entry and exit of intermediaries. We also consider the effect of replacing uninsured by insured deposits, market power in raising deposits, and funding with both deposits and capital.

Keywords: Imperfect competition; Intermediation margins; Bank monitoring; Bank risk-taking; Monetary policy (search for similar items in EconPapers)
JEL-codes: E52 G21 L13 (search for similar items in EconPapers)
Date: 2020-07
New Economics Papers: this item is included in nep-ban, nep-com, nep-cwa, nep-fdg, nep-mac and nep-mon
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Citations: View citations in EconPapers (5)

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Working Paper: Interest Rates, Market Power, and Financial Stability (2020)
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