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Banking competition and regulation with diverse business models
Peter Eccles1, Paolo Siciliani1, Paul Grout2, Ania Zalewska3
1Bank of England. UK; 2University of Bristol, UK; 3University of Leicester, UK
We develop a model of banking competition where there is a partition between passive depositors who always deposit funds at the same bank and active depositors who can observe and act on all deposit rates in the market. This partition leads to two opposite business models where banks choose either to be (i) a monopolistic bank and serve only passive depositors or (ii) a competitive bank and also serve active depositors. Prudential regulation needs to account for its impact on the relative attractiveness of these two business models. We show that this additional effect, of banks switching between business models, can offset the traditional impact of capital requirements, in that an increase in capital requirements can trigger an intensification of competition, which in turn can increase overall risk-taking. Similarly, the imposition of a deposit-rate ceiling may render the competitive business model comparatively more appealing. We also show that in this situation the introduction of shadow banks has the potential to reduce rather than increase overall risk-taking.
