DP1177 Imperfect Competition, Risk Taking, and Regulation in Banking
|Author(s):||Carmen Matutes, Xavier Vives|
|Publication Date:||May 1995|
|Keyword(s):||Asset Restrictions, Excessive Competition, Investor Protection, Limited Liability, Rate Regulation, Risk Taking|
|Programme Areas:||Financial Economics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=1177|
We develop a model of banking competition which allows us to disentangle the roles that limited liability, deposit insurance (both with flat and risk-based premia), and rivalry for deposits play in determining risk-taking incentives both in the asset and the liability side of the balance sheet. We find that in all market configurations (uninsured or insured) banking rivalry yields excessive deposit rates when social failure costs are high or when competition is intense. Maximal risk-taking incentives (on the liability and asset sides) exist with flat-premium deposit insurance and minimal with risk-based insurance. In an uninsured market risk taking on the asset side is implied by limited liability and the presence of moral hazard (asset risk not observable). With flat-premium deposit insurance maximum risk-taking incentives exist even if there is no moral hazard. Finally, we can extricate the role of rate and asset regulation both in the case of insured and uninsured deposits.