"Market power and banking failures," International Journal of Industrial Organization Volume 20, Issue 9, November 2002, pages 1341-61.
JEL codes: D4, D82, G21
Keywords: moral hazard, credit rationing, monitoring, market power, banking failures
Abstract: We investigate whether more competition in the banking industry necessarily results in a higher probability of bank failures, as it is often suggested. In our model borrowers face a moral hazard problem, which induces banks to choose between costly monitoring and credit rationing. We show that investment decreases with the lending rate and increses with monitoring effort. Since incentives to monitor are enhanced by market power, the relationship between market stucture and investment is ambiguous. In the presence of non-diversifiable risk and decreasing returns to scale, more investment implies higher failure rates. As a result, the relationship between market power and banking failures is ambiguous.