Competition, Stability, and Efficiency in Financial Markets

We find that (1) an intensification of competition increases the efficiency and fragility of banks; (2) economies can avoid the fragility costs of competition by enhancing bank governance and tightening leverage requirements; and (3) the monetary transmission mechanism is materially shaped by bank competition in that bank lending responds more aggressively to central bank induced changes in interest rates in more competitive environments. Our research stresses the importance of (a) regulations that improve bank governance because they boost efficiency and stability and (b) explicitly accounting for the structure of the banking system when assessing regulatory and monetary policy.

Dean Corbae and Ross Levine

Federal Reserve Bank of Kansas City

August 10, 2018

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