Working Paper: CEPR ID: DP1939
Authors: Tito Cordella; Eduardo Levy Yeyati
Abstract: This paper studies the impact of competition on the determination of interest rates, and on banks? risk taking behaviour, under different assumptions about deposit insurance and the dissemination of financial information. We find that lower entry costs foster competition in deposit rates and reduce banks? incentives to limit risk exposure. While higher insurance coverage amplifies this effect, two alternative arrangements (risk based contributions to the deposit insurance fund, and public disclosure of financial information) contribute to reduce it. Moreover, uninsured but fully informed depositors and risk based full deposit insurance yield the same, entry cost independent, equilibrium risk level. The welfare implications of the different arrangements are also explored.
Keywords: banks; bank competition; deposit insurance; financial opening; information disclosure; monopolistic competition; risk
JEL Codes: O82; G14; G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increased insurance coverage (G52) | Higher deposit rates (E43) |
| Increased insurance coverage (G52) | Higher risk (D81) |
| Increased insurance coverage (G52) | Lower bank margins (G21) |
| Lower bank margins (G21) | Reduced incentives to monitor risk position (G21) |
| Lower entry costs (D49) | Higher deposit rates (E43) |
| Lower entry costs (D49) | Reduced incentives to monitor (D82) |
| Pricing of risk (G19) | Shift from price competition to quality competition (L15) |
| Shift from price competition to quality competition (L15) | Lower deposit rates (E43) |
| Shift from price competition to quality competition (L15) | Lower risk (G52) |
| Competition dynamics (L13) | Influence on risk-taking behaviour (D91) |
| Competition dynamics (L13) | Higher bank profits in the short run (G21) |
| Competition dynamics (L13) | Greater number of banks in the long run (G21) |
| Method of risk assessment (C52) | Affects equilibrium risk level (D53) |
| Financial opening (G29) | Smaller negative impact on risk-taking behaviour (D91) |