The Political Economy of Banking Competition

Abstract

This paper provides a banking competition rationale for the financial deregulation waves that happened in the United States from the 1980s onward. I claim that institutions that could take advantage of technological and regulatory advantages (shadow banks) gained market power with respect to traditional banks. In light of this element, the paper sees the waves of financial deregulation as the by-product of higher asymmetric competition in the banking system, which led traditional banks to lobby harder in order to level the playing field. As such, the paper is able to produce a root cause explanation for the financial deregulation process and its timing. I build a model to illustrate these dynamics, and run some preliminary empirical analyses. The model allows also for financial innovations to be pursued as a temporary and alternative mechanism to cope with failed lobbying attempts. The paper highlights the daunting task of providing macro-prudential policies and financial market regulation in a political economy environment in which lobbying against regulation itself and regulatory arbitrage are possible.

Keywords: Financial deregulation, shadow banking system, lobbying, political economy of finance, financial innovation G21

JEL Classification: G21, G23, G28, N22, N42, P19