Banking Systems in a Financially Integrated World
| Author | Giovanni Dell'Ariccia |
| Pages | 4-6 |
Page 4
Financial reforms have eased legal barriers to entry, liberalized deposit and loan rates, relaxed restrictions on bank portfolios and ownership, and reduced reserve requirements. This process has also often involved the redesigning of prudential regulation and supervision, and a reduced public presence in the banking sector. Moreover, substantial theoretical work in the last 20 years has emphasized the role played by information in credit markets. 1
A number of studies at the IMF have, therefore, focused on the interaction between information, bank market structure, and liquidity allocation. 2
These studies show that the superior knowledge about borrower creditworthiness, which incumbent banks possess relative to new entrants, represents a barrier to entry in the banking industry. When faced with increased competition from foreign institutions, domestic banks reallocate their portfolio toward those market segments where their informational advantage is greater (for example, loans to small enterprises) and where returns, but also risks, are higher.
The traditional industrial organization framework predicts that competition should reduce the costs and prices of banking services and lead to an efficient allocation of aggregate liquidity. More recent theories focusing on the special role played by information in banking have argued, instead, that standard models of competition are inappropriate for the banking sector. These studies have emphasized that competition may lead banks to take greater risks thereby making the financial system more fragile, and that, in the presence of informational asymmetries, greater bank competition may reduce, rather than increase, the aggregate supply of bank credit to the economy. IMF researchers have examined this issue from both a theoretical and an empirical point of view. Sarr (2000) presents a model where profit-maximizing banks are willing to reduce account fees when they have market power that allows them to reduce deposit rates. The overall effect is a reduction of the cost of deposits and, hence, increased financial deepening. 3
Several empirical papers focus on the effects of bank competition and entry on intermediation spreads and credit availability. A number of these studies examine single-country cases. For example, Barajas, Steiner, and Salazar (1999) find that financial liberalization and foreign entry had a beneficial impact on bank behavior in Colombia by enhancing operative efficiency and increasing competition. 4
Other studies analyze panels of countries. Martinez-Peria and Mody (2002) use panel data from five Latin American countries and find that foreign bank entry tends to promote competition by reducing administrative costs, and that foreign banks charge lower intermediation spreads than do their domestic competitors. Grigorian and Manole (2002) examine commercial bank performance in a panel of 17 transition economies. They find that bank consolidation and foreign ownership and control are likely to improve the efficiency of banking operations. Bonaccorsi di Patti and Dell'Ariccia (forthcoming) find a nonlinear relationship between bank competition and the creation of new firms, suggesting that some competition is "good," but too much competition is "bad." 5
Furthermore, consistent with the prediction of recent theories of financial intermediation, they find that bank competition is more favorable to firms operating in sectors characterized by less severe information problems...
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