A Quantitative Model of Banking Industry Dynamics

Dean Corbae and Pablo D’Erasmo

Journal of Political Economy Macroeconomics, 2025, vol. 3, issue 4, 621 - 673

Abstract: We develop a simple model of banking industry dynamics to study the relation between market structure and financial stability. Motivated by data, we analyze an environment where a small number of dominant (nonatomistic) banks strategically interact with a large number of small (atomistic) banks. A nontrivial endogenous bank size distribution arises out of entry and exit in response to aggregate and regional shocks to borrowers’ production technologies and banks’ idiosyncratic deposit inflows. Since the model has nonatomistic banks that generate granular spillovers from idiosyncratic shocks and pose systemic risk, we use the model to study the implications of too-big-to-fail policies.

Date: 2025
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