Download Main Features of the Model

SIMPOSIO ANÁLISIS
ECONÓMICO
ZARAGOZA, 11-13 DIC. 2009
Banking Deregulation, Banking
Development and Endogenous Growth
Diego Romero-Ávila
Universidad Pablo de Olavide
OBJECTIVE

1)To show the relationship between
banking deregulation, banking
development and endogenous growth.

2) To highlight the real benefits from
banking deregulation in a context of
monopolistic competition
in
the
banking market.
Empirical Background
1)Jayaratne and Strahan (1996) find that
banking deregulation in the form of
relaxing bank branch restrictions in the
US increased efficiency and growth.
2) Romero-Ávila (2007, 2009) find that
banking harmonisation and interest
rate deregulation also increased
efficiency and growth.
Theoretical Framework

We adopt a standard knowledge-driven
endogenous
growth
model
a
la
Grossman and Helpman (1991) which
assumes a vertically integrated real
economy with three sectors: final good
firms, intermediate good firms and
research firms.
Main Features of the Model
Household Sector
Infinitely-live agents.

Logarithmic UF
e
 t
ln( C )dt
0
Households supply a fixed amount of HK into
intermediate goods and banking sectors.
So there is no schooling sector as in
Arnold (1998).
Main Features of the Model
The real economy consists of three sectors
vertically integrated.
Consumption (Final) Good Sector
The technology is CES-type
1

 nt



 ,   (0,1)
C

x
(
i
)
di
with equal share for all x(i)


0

n is the range of intermediate goods and represents
the stock of knowledge.
Main Features of the Model
Intermediate Goods Sector
Produces x(i) using human capital with a
linear technology: nx  H
x
Each firm needs to buy a brand or idea (entry
cost) in order to operate.
This allows firms to enjoy market power over
its
differentiated
good
(Monop.
Competition).
Main Features of the Model
Research Sector
Research firms use financial resources
provided by banks (F) and the stock of
knowlegde via externality (n) to generate
 
ideas:
, (0,1).
n  n F
Number of R&D projects financed equals M,
so for a given loan size: F=ML.
Banking
MainSector
Features
of the Model
Monopolistically competitive agents.
Tasks: 1) Maturity transformation, 2) Evaluation of R&D projects
and 3) financing those R&D firms with good prospects.
b ( j )  r b L  r d d
Each bank j maximises
subject to the
balance sheet equilibrium L=d and the demand for loans.
r b  Pn n (ML) 1 .
This renders r  r /  .
b
d
We assume N banks operating at any t and only M are succesful
in finding and funding a good project (M successful projects).
So M is the stock of knowledge created from the evaluation
of succesful R&D projects.
The total HK employed in banking is H f 
assumes an entry cost in the form of HK.
Nh f
. Each bank
Banking
Technology:
MainSector
Features
of the Model
Deregulated Regime
Technology is a concave function of the stock of
knowledge in banking M and the HK employed
per each bank:  ( Mh f )
This can be also seen as the probability that a bank
finds an R&D firm for which to provide funding.
Mh f  e represents the efficiency units of input.
At the aggregate level, M   (Mh f ) N   (e) N
Banking
Technology:
MainSector
Features
of the
Regulated Regime
Model
We assume that the presence of the externality in
the banking technology captures the positive
effect of banking deregulation on the efficiency
with which banks gather information and
evaluate potential start-ups.
So in a regulated regime where banks cannot share
such information, the externality does not exist,
and efficiency is only a function of HK.
 (h f )
Solution to the model.
Steady State results: Deregulated Regime
From the optimisation program for each of the N
banks
  r ( t )

Vb ( j )   ( Mh f )  e
 b ( j , )d   wh f
t

we find that e  e * is constant.
This together with the solution of the optimisation
program of manufacturing and research firms,
and consumers, which are standard in this
literature, we obtain
g  g  g  g  g
*
N
*
M
*
F
*
hf
*
rb
Solution to the model.
That condition implies the following:
1) The greater the number of banks gathering information about
potential start-ups (N), the greater the number of R&D
projects successfully evaluated and financed (M) and the
greater the supply of funds to research (F).
2) For a fixed amount of human capital ( H f  Nh f
), if N
increases, h
must decrease, thus reducing efficiency.
f
However, if N increases, M does so, which offsets the
previous effect, thus leaving banking efficiency e  Mh f
unchanged.
3) Intensified competition among banks leads to progressively
close the wedge between the deposit rate (which is given)
and the loan rate.
Solution to the model
From the law of motion of M, we have:
N
N
g M   ( Mh f )
M , where M  m . m is the ratio
of the potential flow of R&D projects to be
evaluated and financed relative to the
stock of existing R&D projects.
So the steady state growth rate equals:
*
g F (e)m
*
gn 

1   (1   )
Regulated
Regime
Main Features
of the Model
In this regime the following steady state condition
applies: g *N  g M*  g F*   ghf*   g *b  0
*

g
and g n*  F  0
1
hf  hf *
In this case,
r
which is unique. Since the
aggregate supply of HK is given, and there is no longer
an information externality in the banking technology
 (h f ) now each bank would have to reduce their HK
individually if a new bank entered the industry, thus
reducing banking efficiency. This is no longer
compensated with the information externality as occurs
in the other scenario. So no new banks enter the
industry.
Solution to the model
Thus the deregulation of the banking industry, which we
capture through an externality, conditions the
development and expansion of the banking sector and
in turn the development of the three sectors of the real
economy.
So if no more banks enter the industry, no more R&D firms
can be evaluated and financed, and the research sector
stops producing new ideas, which in turn affects the
intermediate goods sectors which cannot expand, and
also the consumption goods sector which does not
experienced increases in factor-saving productivity.
Policy Implications

Our findings appear to back up empirical
findings Jayaratne and Strahan (1996) and
Romero-Ávila (2007, 2009) who find
significant positive growth effects from
banking deregulation.

So policymakers should make the effort to
deregulate their banking sectors so that
real benefits can be reaped from the
integration of financial systems, which
provide advantages in terms of capital
costs and the volume of funds available.
Conclusions

1) Banking deregulation leads to
greater banking activity through the
entry of more banks, which in turn
leads to more R&D activity by
evaluating and funding more research
firms.

2)Banking development by itself, if it is
not accompanied by banking
deregulation, does not have any effect
on the growth of the real economy.