Financial Intermediation, Competition, and Risk: a General Equilibrium Exposition
39 Pages Posted: 19 Mar 2010
Date Written: March 1, 2010
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, they are empirically relevant, and carry significant implications for financial policy.
Keywords: General Equilibrium, Bank Competition, Market Power Rents, Risk
JEL Classification: D5, G21
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