Banking Competition, Capital Accumulation, and Monetary Policy

In recent years, the increased concentration of activity in the banking system has received much attention. This paper studies the implications of concentration in the banking sector for economic activity. Changes in the competitive structure affect investment, risk-sharing, and social welfare. A key aspect of our analysis is that banks in more concentrated systems allocate a lot of resources towards cash reserves rather than investing in productive assets. However, perfect competition should not be a regulatory goal for the banking system. The model also demonstrates that the effi cacy of monetary policy varies with the degree of concentration. Finally, the optimal money growth rule is increasing in the degree of concentration. Empirical analysis among countries in the OECD is consistent with the main predictions of the model. Such observations are important as regulators and monetary policy authorities confront the challenges of an evolving competitive landscape out of the crisis.