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Banking competition, monitoring incentives and financial stability


Vo, Thi Quynh Anh (2010). Banking competition, monitoring incentives and financial stability. Norges Bank Working Paper 16, University of Zurich.

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 fi?rst effect operates through the link between competition and loan margin. The second effectcomes 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.

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 fi?rst effect operates through the link between competition and loan margin. The second effectcomes 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.

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Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Language:English
Date:2010
Deposited On:22 May 2012 07:47
Last Modified:05 Apr 2016 15:20
Series Name:Norges Bank Working Paper
ISSN:1502-8143
Free access at:Official URL. An embargo period may apply.
Related URLs:http://www.norges-bank.no/en/Published/Papers/Working-Papers/2010/WP-201016/
Other Identification Number:merlin-id:4254
Permanent URL: https://doi.org/10.5167/uzh-54328

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