On the coexistence of banks and markets

Hans Gersbach and Harald Uhlig ()

No 2006-054, SFB 649 Discussion Papers from Humboldt University Berlin, Collaborative Research Center 649: Economic Risk

Abstract: We examine the coexistence of banks and financial markets, studying a credit market where the qualities of investment projects are not observable and the investment decisions of entrepreneurs are not contractible. Standard banks can alleviate moral-hazard problems by securing a portion of a repayment in the case of non-investment. Financial markets operated by investment banks and rating agencies have screening know-how and can alleviate adverse-selection problems. In competition, standard banks are forced to increase repayments, since financial markets can attract the highest-quality borrowers. This, in turn, increases the share of shirkers and may make lending unprofitable for standard banks. The coexistence of financial markets and standard banks is socially inefficient. The same inefficiency can happen with the entrance of sophisticated banks, operating with a combination of rating and ongoing monitoring technologies.

JEL-codes: D43 D80 D92 G24 G28 G32 G38 (search for similar items in EconPapers)
Date: 2006
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Journal Article: On the Coexistence of Banks and Markets* (2007)
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