TY - JOUR
T1 - Competition and the risk of bank failure
T2 - breaking with the representative borrower assumption
AU - Ferreira, Rodolphe dos Santos
AU - Modesto, Leonor
N1 - Funding Information:
The authors wish to thank the Associate Editor and two anonymous referees who reviewed our manuscript for their valuable comments and suggestions. Financial support from Fundação para a Ciência e Tecnologia, Portugal, under the PTDC/IIM‐ECO/4831/2014 and PTDC/EGE‐ECO/27884/2017 is also gratefully acknowledged.
Funding Information:
The authors wish to thank the Associate Editor and two anonymous referees who reviewed our manuscript for their valuable comments and suggestions. Financial support from Funda??o para a Ci?ncia e Tecnologia, Portugal, under the PTDC/IIM-ECO/4831/2014 and PTDC/EGE-ECO/27884/2017 is also gratefully acknowledged.
Publisher Copyright:
© 2021 The Authors. Journal of Public Economic Theory published by Wiley Periodicals LLC.
PY - 2021/8
Y1 - 2021/8
N2 - We examine the relation between intensity of competition in the loan market and risk of bank failure, in a model with adverse selection. As well established, the presence of the two opposite margin and risk-shifting effects creates conditions for nonmonotonicity: the conventional competition-fragility view may be challenged at high interest rates. These rates may however be too high to be compatible with oligopolistic equilibrium conditions. The challenging competition-stability view has been argued in terms of a representative borrower managing the profitability-safeness trade-off under moral hazard. However, the representative borrower assumption is not innocuous, playing down by construction the margin effect. The paper considers the adverse selection situation where that trade-off is managed by banks facing heterogeneous borrowers, and shows analytically, in the case of a trapezoidal distribution of idiosyncratic and systemic risk factors, that the conventional view is always valid.
AB - We examine the relation between intensity of competition in the loan market and risk of bank failure, in a model with adverse selection. As well established, the presence of the two opposite margin and risk-shifting effects creates conditions for nonmonotonicity: the conventional competition-fragility view may be challenged at high interest rates. These rates may however be too high to be compatible with oligopolistic equilibrium conditions. The challenging competition-stability view has been argued in terms of a representative borrower managing the profitability-safeness trade-off under moral hazard. However, the representative borrower assumption is not innocuous, playing down by construction the margin effect. The paper considers the adverse selection situation where that trade-off is managed by banks facing heterogeneous borrowers, and shows analytically, in the case of a trapezoidal distribution of idiosyncratic and systemic risk factors, that the conventional view is always valid.
UR - http://www.scopus.com/inward/record.url?scp=85104085889&partnerID=8YFLogxK
U2 - 10.1111/jpet.12509
DO - 10.1111/jpet.12509
M3 - Article
SN - 1467-9779
VL - 23
SP - 622
EP - 638
JO - Journal of Public Economic Theory
JF - Journal of Public Economic Theory
IS - 4
ER -