Bank regulation and market structure

Carsten Krabbe Nielsen and Gerd Weinrich

International Journal of Industrial Organization, 2023, vol. 88, issue C

Abstract: In our model, banks, heterogeneous in terms of entry costs, compete à la Salop for depositors on the unit circle. When capital requirements, intended to prevent risk shifting, are increased, the resulting costs are passed on to depositors in the form of reduced deposit rates or quality of service. This may induce depositors to migrate to unregulated shadow banks, the consequence being a change in the market structure for regulated banks: for low levels of capital requirements we observe monopolistic competition, while for higher levels constrained oligopoly and, finally, local monopoly. Under the latter two types of market structure, higher capital requirements reduce the profit margins and franchise values of banks, which may have the unintended effect of inducing banks to increase the riskiness of their investments.

Keywords: Capital requirements; Risk shifting; Franchise value effect; Market leakage; Salop model with heterogeneous entry costs; Shadow banks (search for similar items in EconPapers)
JEL-codes: D43 G21 G28 (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:indorg:v:88:y:2023:i:c:s0167718723000267

DOI: 10.1016/j.ijindorg.2023.102944

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