Banking competition and welfare

We develop a simple general equilibrium model in which investment in a risky technology is subject to moral hazard and banks can extract market power rents. We show that more bank competition results in lower economy-wide risk, higher social welfare, lower bank capital ratios, more efficient production plans and Pareto-ranked real allocations. Perfect competition supports a second best allocation and optimal levels of bank risk and capitalization. These results are at variance with those obtained by a large literature that has studied a similar environment in partial equilibrium, they are empirically relevant, and carry significant implications for policy guidance

The Impact of the Basel III Liquidity Coverage Ratio on Macroeconomic Stability: An Agent-Based Approach

Commercial banks across the world have been implementing the Basel III accord, which is the most important international response to the 2007-2008 financial crisis. Particularly, the liquidity coverage ratio (LCR) introduced by the Basel III accord is the first global standard for banking liquidity management. Does this requirement work? And what macroeconomic effects does it produce? In order to address such crucial issues, the author develops a stock-flow consistent (SFC)/agent-based computational economic (ACE) model. As he knows, there is a real danger that the requirement restricts the availability of bank credit and hence reducing economic activity. However, in comparison to the prior works, the author finds that the externality is presented as a positive self-reinforcing feedback process, which causes the macroeconomic conditions to spiral downwards. This dynamic feedback process that hardly can be revealed by the current macroeconomic models based on equilibrium analyses. The results also shed some light on the fact that credit creation substantially affects economic activity and macroeconomic stability, as the fundamental reason leading to the results. Therefore, the bank as the driver of credit creation is crucial in an economy, and meanwhile bank regulations have great potential impacts on entire economy rather than only in the bank sector itself

Competition and Stability in Banking

I review the state of the art of the academic theoretical and empirical literature on the potential trade-off between competition and stability in banking. There are two basic channels through which competition may increase instability: by exacerbating the coordination problem of depositors/investors on the liability side and fostering runs/panics, and by increasing incentives to take risk and raise failure probabilities. The competition-stability trade-off is characterized and the implications of the analysis for regulation and competition policy are derived. It is found that optimal regulation may depend on the intensity of competition

Bank Capital Regulation in a Zero Interest Environment

How do near-zero deposit rates affect (optimal) bank capital regulation and risk taking? I study these questions in a tractable, dynamic equilibrium model, in which forward-looking banks compete imperfectly for deposit funding, subject to a (zero) lower bound constraint on deposit rates (ZLB). At the ZLB, capital requirements become less effective in curbing excessive risk-taking incentives, as they disproportionately hurt franchise values. As a consequence, optimal dynamic capital requirements vary with the level of interest rates if the ZLB binds occasionally. Subsidizing bank funding costs at the ZLB dampens risk-taking, but may reduce overall welfare