Banking Competition, Monitoring Incentives and Financial Stability

22 Pages Posted: 9 Sep 2010  

Vo Thi Quynh Anhy

Norges Bank

Date Written: August 8, 2010

Abstract

This paper addresses the desirability of competition in banking industry. In a model where banks compete on both deposit and loan markets and where banks can use monitoring technology to control entrepreneurs' behavior, we investigate three questions: what are the effects of competition on banks' monitoring incentives? Does competition hurt banks' stability? What can be devices to correct potential negative effects of competition vis à vis financial stability? We find that impacts of competition on banks' monitoring incentives can be decomposed into two effects: one on the attractiveness of monitoring and the other on the monitoring efficiency. The first effect operates through the link between competition and loan margin. The second effect comes from the fact that marginal effect of monitoring on entrepreneur's effort depends on loan rate. We characterize the sufficient condition under which competition will increase monitoring incentives as well as banks' stability. For the third question, we focus on the role of capital requirement and claim that with capital requirement, we can attain a weak correction but not strong correction.

JEL Classification: G21, G28, D43, D82

Suggested Citation

Quynh Anhy, Vo Thi, Banking Competition, Monitoring Incentives and Financial Stability (August 8, 2010). Norges Bank Working Paper 2010/16. Available at SSRN: https://ssrn.com/abstract=1673827

Vo Thi Quynh Anhy (Contact Author)

Norges Bank ( email )

P.O. Box 1179
Oslo, N-0107
Norway

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