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Discussant: Franklin Allen JFI/WB Conference on Bank Regulation and Corporate Finance

Competition and Entry in Banking: Implications for Capital Regulation by Arnoud W. A. Boot and Matej Maren č. Discussant: Franklin Allen JFI/WB Conference on Bank Regulation and Corporate Finance. The Model. Banks financed with equity and deposits Cost of equity > Cost of insured deposits

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Discussant: Franklin Allen JFI/WB Conference on Bank Regulation and Corporate Finance

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  1. Competition and Entry in Banking: Implications for Capital RegulationbyArnoud W. A. Boot and Matej Marenč Discussant: Franklin Allen JFI/WB Conference on Bank Regulation and Corporate Finance

  2. The Model • Banks financed with equity and deposits • Cost of equity > Cost of insured deposits • Regulatory capital minimum k binds • Banks monitor borrowers – the more monitoring the higher is v, the borrower’s probability of high payout • Cost of monitoring = (c/2)(v-vT)2 with vG>vB

  3. The Model (cont.) t=0 t=1 t=2 t=3 -k set by -Borrower -Borrower -Payoffs regulator matched searches for realized with bank competing offer -Banks -Bank type -Prob. q one enter good or bad appears and there discovered is Bertrand comp. -Bank makes -Funds collected first offer -Borrowers do projects

  4. Main Results • With a fixed number of banks, increasing competition (a higher q) improves the monitoring incentives of good banks and reduces those of bad banks • With endogenous entry, increasing capital requirements increases the returns to good banks and reduces the returns to bad banks so there is a “cleansing” effect • In weak banking systems capital regulation is less effective than in strong banking systems

  5. Comments Model is very interesting and much can be done with it • More discussion on the nature of fixed costs helpful • Policy analysis is focused on level of monitoring and thus on stability issues • A welfare analysis would be helpful • What is the optimal number of banks? • What are the set of efficient allocations? • Is a reduction in risk always desirable? • What is the optimal value of k?

  6. Comments (cont.) • What is the size distribution of firms in the solution? • Symmetric equilibria are considered but asymmetric equilibria may also be important • It would be good to prove that the minimum capital constraint k imposed by the regulator is binding

  7. Comments (cont.) • Given a fixed cost of monitoring, would a two part pricing scheme for loans allow an improvement? • What would happen without deposit insurance? • Can the results on foreign entry be related to what happened in Eastern Europe?

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