On the Coexistence of Banks and Markets

20 Pages Posted: 31 Aug 2007

See all articles by Hans Gersbach

Hans Gersbach

ETH Zurich - CER-ETH -Center of Economic Reseaarch; IZA Institute of Labor Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

Harald Uhlig

University of Chicago - Department of Economics

Abstract

We examine the coexistence of banks and financial markets by 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, while financial markets operated by investment banks 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 may occur with the entrance of sophisticated banks, operating with a combination of rating and ongoing monitoring technologies.

Suggested Citation

Gersbach, Hans and Uhlig, Harald, On the Coexistence of Banks and Markets. Scandinavian Journal of Economics, Vol. 109, No. 2, pp. 225-243, June 2007. Available at SSRN: https://ssrn.com/abstract=1010800 or http://dx.doi.org/10.1111/j.1467-9442.2007.00493.x

Hans Gersbach (Contact Author)

ETH Zurich - CER-ETH -Center of Economic Reseaarch ( email )

Zürichbergstrasse 18
Zurich, 8092
Switzerland
+41 44 632 82 80 (Phone)
+41 44 632 18 30 (Fax)

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Harald Uhlig

University of Chicago - Department of Economics ( email )

1101 East 58th Street
Chicago, IL 60637
United States

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