Working Paper: CEPR ID: DP2933
Authors: Enrico C. Perotti; Javier Suarez
Abstract: Banks are highly leveraged institutions, potentially attracted to speculative lending even without deposit insurance. A counterbalancing incentive to lend prudently is the risk of loss of charter value, which depends on future rents. We show in a dynamic model that current concentration does not reduce speculative lending, and may in fact increase it. In contrast, a policy of temporaryincreases in market concentration after a bank failure, by promoting a takeover of failed banks by a solvent institution, is very effective. By making speculative lending decisions strategic substitutes, it grants bankers an incentive to remain solvent. Subsequent entry policy fine-tunes the trade-off between the social costs of reduced competition and the gain in stability.
Keywords: Bank mergers; Banking crises; Charter value; Market structure; Dynamics; Prudential regulation
JEL Codes: G21; G28; L10
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| current market concentration (L11) | speculative lending (G21) |
| temporary increase in market concentration (D43) | speculative lending (G21) |
| policy of increasing market concentration post-bank failure (G28) | strategic substitutes in lending decisions (G21) |
| solvent institutions taking over failed banks (G28) | market concentration (L11) |
| banks motivated to remain solvent (G21) | consequences of failure (G33) |