The Industrial Organization of Banking (eBook)

David VanHoose is an economics professor at the Hankamer School of Buiness atHankamer School of Business at Baylof University. He has written numerous text books and papers which are widely used in the field of economics. His areas of focus are international economics, monetary economics, macroeconomics, and banking. 

The Industrial Organization of Banking 1
Contents 4
1 Introduction 8
Three Fundamental Areas Within the Industrial Organization of Banking 8
Objectives 9
Bank Behavior and the Structure of Banking Markets 10
Bank Competition and Public Policy 11
Assessing Bank Regulation 11
2 The Banking Environment 14
The Bank Balance Sheet 14
Bank Assets 14
Loans 14
Securities 16
Cash Assets 16
Trends in U.S. Bank Asset Allocations 16
Bank Liabilities and Equity Capital 18
Transactions Deposits 18
Large-Denomination Time Deposits 18
Savings Deposits and Small-Denomination Time Deposits 19
Purchased Funds and Subordinated Notes and Debentures 19
Bank Capital 19
Trends in Bank Liabilities and Equity Capital 19
The Bank Income Statement 20
Interest Income 20
Noninterest Income 21
Interest Expenses 21
Expenses for Loan Loss Provisions 22
Real Resource Expenses 22
Bank Profitability Measures 22
Asymmetric Information and Risks in Banking 24
Adverse Selection 24
Moral Hazard 24
Risks on the Balance Sheet 25
Credit Risk 25
Market Risks 25
Liquidity Risk 26
Systemic Risk 26
Risks Off of Bank Balance Sheets 26
Loan Commitments 27
Securitization 28
Derivative Securities 28
Trends in U.S. Banking Industry Structure 29
Recent Patterns in U.S. Banking Structure 29
Mergers, Acquisitions, and Concentration 30
Summary: The Banking Environment 32
3 Alternative Perspectives on Bank Behavior 34
Identifying the Outputs and Inputs of a Bank 34
What Banks Do: Alternative Perspectives on Bank Production 34
Assessing the Economic Outputs and Inputs of Banks 35
Banks as Portfolio Managers 37
The Basic Bank Portfolio-Management Model 37
Limitations of Portfolio Management Models 38
Banks as Firms 38
A Perfectly Competitive Banking Industry 39
A Static Banking Model 39
Fundamental Dynamics in a Perfectly Competitive Banking Model and Implications for Portfolio Separation 45
Imperfectly Competitive Banking Markets 47
Monopolistic and Monopsonistic Interest Rate Determination in Bank Loan and Deposit Markets 48
Social Losses Due to Imperfect Competition in Banking 49
Alternative Modes of Behavior between Perfect Competition and Monopoly and Monopsony 51
Summary: Models of the Banking Firm 57
4 The Industrial Economics of Banking 59
The Structure-Conduct-Performance Paradigm in Banking 59
The SCP Hypothesis with Identical Banks 60
Structural Asymmetry, Dominant Banks, and the SCP Paradigm 61
A Dominant-Bank Model 61
Strategic Entry Deterrence 63
Evaluating the Applicability of the SCP Paradigm to the Banking Industry 64
Traditional SCP Evidence from Cross-Sectional Banking Data 64
Evidence from Cross-Country Studies 66
Dynamic Interest Rate Responses: Competition and Pass-Through Effects 66
The Conduct and Relative Performances of Large and Small Banks 67
Market Structure and BankCustomer Relationships 69
Basic Market-Structure Implications of Bank--Customer Relationships 70
Evidence on Bank--Customer Relationships 72
Determinants and Impacts of Bank--Customer Relationships 72
Competition and Relationship Lending 74
The Efficient Structure Theory and Banking Costs 75
The Efficient Structure Challenge to the SCP Paradigm 76
Banking Efficiency and Costs 76
Efficient Structure Theory and Bank Performance 78
Endogenous Sunk Fixed Costs and Banking Industry Structure 80
Endogenous Sunk Costs and Concentration 81
Non-Price Competition in Banking: Implicit Deposit Rates Versus Quality Rivalry 82
Evidence on Advertising Outlays in the Banking Industry 83
Endogenous Sunk Costs and the Banking Industry 84
Summary: The Industrial Organization of Banking 86
5 The Economics of Banking Antitrust 88
Why Banks Merge 88
Profit Enhancements from Mergers 88
Diversification Benefits of Bank Mergers 91
Assessing Loan and Deposit Market Effects of Bank Consolidation 92
Mergers in Initially Perfectly Competitive Banking Markets 92
Mergers in Initially Imperfectly Competitive Banking Markets 94
Evidence on the Consequences of Banking Consolidation 95
Mergers and Market Power 95
Evidence on Efficiency Gains from Banking Consolidation 97
Banking Antitrust in Practice 98
U.S. Bank Merger Guidelines U.S. Bank Merger Guidelines 99
The Relevant Market 99
Merger Screening 100
Evaluating the U.S. Bank Merger Guidelines 102
Is the Official Relevant Banking Market Really Relevant? 102
Do the Formal Guidelines Mis-Measure Market Power? 104
Implications of Endogenous Sunk Fixed Costs 105
Do Banking Consolidations Preclude Entry and Reduce Consumer Welfare? 106
Rethinking Bank Merger Analysis 107
Antitrust Issues in Bank Payment Networks 109
Bank Cards and Two-Sided Markets 110
Card Payment Networks as Two-Sided Markets 110
Multiple Actors and Pricing Structures in Card Payment Networks 112
Regulatory and Antitrust Issues in Card Payment Networks 117
Summary: Banking Antitrust 118
6 Bank Competition, Stability, and Regulation 120
Banks as Issuers of Demandable Debt 120
The Diamond--Dybvig Model 121
An Optimal Risk-Sharing Contract 121
The Diamond--Dybvig Intermediation Solution and the Problem of Runs 122
Evaluating the Diamond--Dybvig Analysis 123
Banks as Screeners and Monitors 125
Evidence on Bank Monitoring Activities 125
Evidence from Bank Loan Announcement Effects 126
Evidence from Firm Investment and Bond Yields 126
Evidence from Syndicated Loans and Loan Sales 127
Direct Evidence of Bank Monitoring Activities 128
A Monitoring Model with Heterogeneous Banks 128
Behavior of Monitoring and Nonmonitoring Banks 129
Loan Market Equilibrium and Equilibrium Monitoring 130
The Relationship between Banking Competition and Risks 131
Perfect Competition and Bank Risks 132
The ''Excessive Deposit Competition'' Argument 132
The Competition-Illiquidity Argument 133
The Competition-Asset Risk Argument 134
Market Power and Bank Risks: Theory and Evidence 135
Competition and Risk: Theory 135
Bank Size, Competition, and Risk: Evidence 136
Deposit Insurance, ''Too Big to Fail'' Doctrine, Basel I, and Basel II 137
The Distorting Effects of Deposit Insurance 138
The Impact of the Too-Big-to-Fail Doctrine 139
Basel I, Capital Regulation, and the Three Pillars of Basel II 140
Summary: Bank Competition, Stability, and Regulation 141
7 Capital Regulation, Bank Behavior, and Market Structure 143
The Portfolio Management Perspective on Capital Regulation 143
The Bank as a Competitive, Mean-Variance Portfolio Manager Facing Capital-Constrained Asset Portfolios 144
Taking Deposit Insurance Distortions into Account 146
Explaining the Mixed Implications of Portfolio Management Models 147
Asset-Liability Management under Capital Regulation 149
An Incentive-Based Perspective on Capital Regulation 149
Incentives and Capital Requirements 150
Perfect Competition Models of Bank Capital Regulation 150
Monopolistic Competition Models of Capital Regulation 154
Demandable Debt, Bank Risks, and Capital Regulation 156
Capital Regulation and Fragile Deposits 156
Moral Hazard, Bank Lending and Monitoring, and Capital Regulation 158
Capital Regulation and Bank Heterogeneities 159
Adverse Selection and Capital Regulation 160
Capital Requirements, Heterogeneous Banks, and Industry Structure 161
Capital Regulation, Credit Shocks, and Procyclicality and Risk 164
Does Toughening Capital Requirements Boost Bank Capital Ratios and Create Credit Shocks? 165
Procycical Features of a Capital-Regulated Banking Industry 167
Empirical Evidence on Procyclical Effects of Capital Regulation 169
Summary: Capital Regulation, Bank Behavior, and Market Structure 170
8 Market Discipline and the Banking Industry 172
The Market Discipline Pillar of Basel II 173
The Channels of Market Discipline 174
Motivations of Agents Who Discipline Banks 174
Conditions for Market Signals to Effectively Discipline Banks 175
Potential Benefits and Costs of Market Discipline in Banking 176
Evaluating Incentives for Information Disclosure 176
Ways to Enhance Bank Market Discipline 177
Industry Structure and Market Discipline 180
Market Discipline in a Basic Banking Model 180
Market Power, Information Disclosure, and Market Discipline 181
Evidence on Market Discipline’s Effectiveness 183
Information Content of Market Prices and Bond Yield Spreads under Basel I 184
Market Discipline versus Regulation 185
Regulatory Crowding Out of Market Discipline? 186
Additional Evidence on Interactions between Regulation and Market Discipline 187
Evidence on Bank Information Disclosure 188
Evaluating the Market Discipline Pillar vis-à-vis the Other Pillars of Basel II 190
The Limitations of Market Discipline under Basel II 190
Theory versus Reality under Basel II's Market Discipline Pillar 191
Summary: Market Discipline and the Banking Industry 192
9 Regulation and the Structure of the Banking Industry 195
Public Interest versus Public Choice Perspectives on Bank Regulation Public Interest versus Public Choice Perspectives on Bank Regulation 195
Public Interest and the Alleged ''Need'' for Bank Regulation 196
Public Choice Motivations for Bank Regulation 196
Applying the Economic Theory of Regulation to the Banking Industry 197
Assessing the Implications of the Economic Theory of Regulation 198
A Generalized Perspective on Evaluating Bank Regulation 200
The Political Economy of Banking Supervision Conducted by Multiple Regulators: Is a Race to the Bottom Unavoidable? 201
Regulatory Preferences and Bank Closure Policies 201
Competition among Bank Regulators 203
A Theory of Optimal Supervisory Choices of a Single Bank Regulator 203
The Case of Competing Regulators 205
A Supervisory Race to the Bottom? 206
Should Bank Regulation Be in the Hands of Monetary Policymakers? 207
The Supervisory Review Process Pillar of Basel II 209
The Supervisory Review Process Pillar: Conceptual Issues 211
Discretion Versus Rules 211
How Tough Should a Supervisory Policy Rule Really Be? 212
When Is International Coordination of Bank Regulation Appropriate? 214
Is There Really a Basel II Supervisory Review Process? 215
Regulatory Compliance Costs and Industry Structure 216
Assessing Banks' Costs of Basel II Compliance: Economies of Regulation? 216
Rule-of-Thumb Estimates 217
Estimates of Basel II Compliance Costs Based on Survey Data 217
“Economies-of-Basel II”—Scale Advantages in Basel II Compliance? 218
To What Extent Do Basel II Compliance Costs ''Matter''? 220
Bank Regulation and Endogenous Fixed Costs 222
Regulatory Compliance Costs: A Missing Component? 222
Regulatory Sunk Fixed Costs 223
Summary: Regulation and Bank Industry Structure 224
References 226
Index 255