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Economic Perspectives, Vol. 25, 2nd, No. 2, May 2001
Competition among banks: Good or bad?
In recent years we have witnessed a substantial convergence of research interest and the opening of a debate on the economic role of market competition in the banking industry. The need for such a debate may seem unjustified at first. The common wisdom would hold that restraining competitive forces should unequivocally produce welfare losses. Banks with monopoly power would exercise their ability to extract rents by charging higher loan interest rates to businesses and by paying a lower rate of return to depositors. Higher lending rates would distort entrepreneurial incentives toward the undertaking of excessively risky projects, thus weakening the stability of credit markets and increasing the likelihood of systemic failure. Higher lending rates would also limit firms. investment in research and development, thus slowing down the pace of technological innovation and productivity growth. Lower supply of loanable funds, associated with higher lending rates, should also be reflected in a slower process of capital accumulation and, therefore, in a lack of convergence to the highest levels of income per capita.
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