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On the coexistence of banks and markets

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  • Gersbach, Hans
  • Uhlig, Harald

Abstract

We examine the coexistence of banks and financial markets, studying a credit market where the qualities of investment projects are not observable and the investment decisions of entrepreneurs are not contractible. Standard banks can alleviate moral-hazard problems by securing a portion of a repayment in the case of non-investment. Financial markets operated by investment banks and rating agencies have screening know-how and can alleviate adverse-selection problems. In competition, standard banks are forced to increase repayments, since financial markets can attract the highest-quality borrowers. This, in turn, increases the share of shirkers and may make lending unprofitable for standard banks. The coexistence of financial markets and standard banks is socially inefficient. The same inefficiency can happen with the entrance of sophisticated banks, operating with a combination of rating and ongoing monitoring technologies.

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  • Gersbach, Hans & Uhlig, Harald, 2006. "On the coexistence of banks and markets," SFB 649 Discussion Papers 2006-054, Humboldt University Berlin, Collaborative Research Center 649: Economic Risk.
    • Handle: RePEc:zbw:sfb649:sfb649dp2006-054
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    Cited by:

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    2. Solomon, Bernard-Daniel, 2008. "Banks as Better Monitors and Firms' Financing Choices in Dynamic General Equilibrium," MPRA Paper 23958, University Library of Munich, Germany, revised 01 Jun 2010.
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    4. Gersbach, Hans & Uhlig, Harald, 2006. "On the coexistence of banks and markets," SFB 649 Discussion Papers 2006-054, Humboldt University Berlin, Collaborative Research Center 649: Economic Risk.
    5. Hans Gersbach & Harald Uhlig, 2007. "On the Coexistence of Banks and Markets," Scandinavian Journal of Economics, Wiley Blackwell, vol. 109(2), pages 225-243, June.

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    More about this item

    JEL classification:

    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection

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