Credit Market Competition, Efficient Banking, and Causes of Financial Crisis
Date Issued
2007
Date
2007
Author(s)
Lin, Yung-Chiao
DOI
en-US
Abstract
This paper develops a theory of banking and financial crisis based on commercial banks' asset substitution problem which may take place when the residual supply of loanable funds facing each bank drops because of entry of new banks or a rise of interest rates in other countries. The latter results in an increase in the deposit rate that commercial banks must offer to households in equilibrium, and given a higher face value of debt, commercial banks would like to raise the riskiness of its loans by altering its monitoring intensity, which may lead to a higher probability of default and bank distress.
For an economy which is technologically narrow in the sense that loan applicants tend to have risky projects yielding highly positively correlated cash flows, a drastic rise in the deposit rate tends to result in less bank monitoring, which raises the likelihood of the event that ex-post many loan applicants default simultaneously, creating a collapse in both the banking system and prices of securities. At the other extreme, where an economy is technologically complementary in the sense that loan applicants' risky projects yield highly negatively correlated cash flows, a rise in the deposit rate may induce commercial banks to monitor more.
Besides the results regarding financial crisis, this paper also derives new insights regarding banking efficiency and provides rationales for the recently documented patterns in underwriters' pricing behavior and issuing firms' choices of underwriters. We consider three major functions of banks, screening, monitoring, and underwriting, and obtain the following results: (i) Unlike in Boot and Thakor (2000), where it is predicted that bank lending shrinks when loan applicants gain access to capital markets, we show that the opposite may actually happen to screening banks. (ii) Even if banks provide totally
differentiated services, entry of new banks may induce monitoring banks to monitor less. (iii) When commercial banks are allowed to compete with investment houses for the underwriting of securities, in equilibrium small firms and large firms tend to be served by respectively commercial banks and investment houses. (iv) The issues underwritten by universal banks tend to have a higher quality than those underwritten by investment houses. (v) When underwriters are different in size, in equilibrium we show that the higher quality underwriters, which are larger in size, have the more severe mispricing problem of underwritten securities.
Subjects
資本市場競爭均衡
資產替代
銀行監督
計畫審查
承銷
金融風暴
價格低估
credit market competition
asset substitution
bank monitoring
project screening
underwriting
financial crisis
underpricing
size effect
Type
thesis
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