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- W53014586 abstract "We consider a two-period model of a banking system to explore the effects of competition on the stability and efficiency of economic activity. In the model, competing banks lend to entrepreneurs. After entrepreneurs receive the loans for their projects, there is a probability of a shock. The shock implies that a fraction of firms will default and be unable to pay back their loans. This will require banks to use their capital and reserves to pay back depositors, restricting second period lending, thus amplifying the economic effect of the initial shock. There are two possible types of equilibria: a prudent equilibrium in which banks do not collapse after the shock, and an imprudent equilibrium where banks collapse. We examine the effects of increased competition in this setting.First, we find existence conditions for a prudent equilibrium. Second, we show that the effect of increased banking competition is to increase the efficiency of the economy at the expense of increased variance in second period economic results. In particular, if the probability of a shock is small, increased competition raises both expected GDP over the two periods and expected activity in the second period, after the shock. Increased competition also increases the attractiveness of imprudent equilibria.Unpredicted regulatory forbearance in the aftermath of a shock can be used to reduce or eliminate the variance in economic activity. However, if regulatory forbearance is expected in response to a shock, the effect on the variance of economic activity after the shock is ambiguous and can even lead to increased variance after a shock. Finally we show that independently of the type of equilibria or the possibility of a switch among types of equilibria, Increased banking competition increases the amplification effect after a shock." @default.
- W53014586 created "2016-06-24" @default.
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- W53014586 date "2013-01-01" @default.
- W53014586 modified "2023-09-27" @default.
- W53014586 title "Banking Competition and Economic Stability" @default.
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- W53014586 doi "https://doi.org/10.2139/ssrn.2277246" @default.
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