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Financial Intermediation, Competition, and Risk; A General Equilibrium Exposition

Gianni De Nicolo and Marcella Lucchetta ()

No 09/105, IMF Working Papers from International Monetary Fund

Abstract: We study a simple general equilibrium model in which investment in a risky technology is subject to moral hazard and banks can extract market power rents. We show that more bank competition results in lower economy-wide risk, lower bank capital ratios, more efficient production plans and Pareto-ranked real allocations. Perfect competition supports a second best allocation and optimal levels of bank risk and capitalization. These results are at variance with those obtained by a large literature that has studied a similar environment in partial equilibrium. Importantly, they are empirically relevant, and demonstrate the need of general equilibrium modeling to design financial policies aimed at attaining socially optimal levels of systemic risk in the economy.

Keywords: Competition; Corporate sector; Banking sector; Banks; Capital; Borrowing; Economic models; Financial risk; Financial intermediation; Risk management; Investment; General Equilibrium, Bank Competition, Market Power Rents, Risk, moral hazard, banking, deposit insurance, bank risk, bank capitalization, (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban and nep-rmg
Date: 2009-05-01
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Working Paper: Financial Intermediation, Competition, and Risk: A General Equilibrium Exposition (2010) Downloads
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