Income Inequality, Banking Competition, and Monetary Policy

Abstract

In recent years, there has been increasing interest in understanding the determinants of income inequality across countries. There have also been concerns about the degree of concentration in the banking system on economic activity. Yet, there has not been any work which focuses on the level of development of the banking system for income inequality. Notably, we ask the the fundamental question: "Does the concentration of assets in the banking system contribute to the concentration of income in society?" In particular, we develop a rigorous general equilibrium model of banking concentration with heterogeneous agents and microeconomic functions for financial intermediaries. The model predicts that concentrated banks contribute to inequality by holding large amounts of liquid assets in order to raise private -- but not social -- returns from capital investment. In turn, the degree of income inequality is adversely affected by the strategic incentives of banks in the financial system. Next, we provide valuable empirical evidence in support of the predictions of our model using recently assembled data on income inequality and banking concentration across countries. We also control for other aspects of financial development such as the size of the stock market and find that the role of banking concentration may be more important for inequality. Consequently, the concentration of assets in the banking system has a profound impact on the concentration of income in society.

Keywords: Inequality, Bank Concentration, Monetary Policy