Competition and Entry in Banking: Implications for Capital Regulation

49 Pages Posted: 19 Jun 2006

See all articles by Arnoud W. A. Boot

Arnoud W. A. Boot

University of Amsterdam - Amsterdam Business School; Centre for Economic Policy Research (CEPR); Tinbergen Institute

Matej Marinc

University of Ljubljana - Faculty of Economics

Date Written: February 4, 2007

Abstract

We assess how capital regulation interacts with the degree of competitiveness of the banking industry. We particularly ask two questions: i) how does capital regulation affect endogenous entry; and ii) how do changes in the competitive environment affect bank monitoring choices and the effectiveness of capital regulation? Our approach deviates from the extant literature in that it allows for heterogeneous bank quality and recognizes the fixed costs associated with the banks' monitoring technologies. Our most striking result is that increasing costly capital requirements can lead to more entry into banking, essentially by reducing the competitive strength of lower quality banks. We show that an implication of this is that banks may want the regulator to impose a higher capital requirement on the industry than is socially optimal. We also show that competition improves the monitoring incentives of better quality banks and deteriorates the incentives of lower quality banks; and that precisely for those lower quality banks competition typically compromises the effectiveness of capital requirements. We generalize the analysis along a few dimensions, including an analysis of the effects of asymmetric competition, e.g. one country that opens up its banking system for competitors but not vice versa.

Keywords: Competition, entry, capital regulation, banking

JEL Classification: G28, G21

Suggested Citation

Boot, Arnoud W. A. and Marinc, Matej, Competition and Entry in Banking: Implications for Capital Regulation (February 4, 2007). EFA 2006 Zurich Meetings; Amsterdam Center for Law & Economics Working Paper No. 2005-07. Available at SSRN: https://ssrn.com/abstract=744787 or http://dx.doi.org/10.2139/ssrn.744787

Arnoud W. A. Boot (Contact Author)

University of Amsterdam - Amsterdam Business School ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands
+31 20 525 4162 (Phone)
+31 20 525 5318 (Fax)

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

Matej Marinc

University of Ljubljana - Faculty of Economics ( email )

Kardeljeva ploscad 17
Ljubljana, 1000
Slovenia

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