Working Paper: CEPR ID: DP1665
Authors: Ramon Caminal; Carmen Matutes
Abstract: We analyse the impact of market structure on the probability of banking failure when banks? loan portfolios are subject to aggregate uncertainty. In our model borrowers are subject to a moral hazard problem, which induces banks to choose between two second-best alternative devices: costly monitoring and credit rationing. We show that investment depends on both the lending rate and the information structure. Since monitoring incentives increase with interest rate margins, the relationship between market structure and investment is ambiguous. Also, larger investment levels imply that the expected return of marginal projects is lower and thus banks? portfolios are more vulnerable to aggregate uncertainty. Consequently, a monopoly bank monitors borrowers more intensively, rations the amount of credit less frequently and hence may go bankrupt with higher probability than competitive banks.
Keywords: moral hazard; credit constraints; monitoring; banking competition; bankruptcy
JEL Codes: G21; D82
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| market structure (monopoly) (D42) | monitoring behavior of banks (G21) |
| monitoring behavior of banks (G21) | probability of bankruptcy (G33) |
| market structure (competition) (L11) | monitoring behavior of banks (G21) |
| monitoring behavior of banks (G21) | solvency of banks (G21) |
| higher interest rates (E43) | monitoring behavior of banks (G21) |
| loan size (G51) | probability of bankruptcy (G33) |
| market structure (monopoly) (D42) | probability of bankruptcy (G33) |
| market structure (competition) (L11) | solvency of banks (G21) |