Dominant bank oligopoly and economic stability

Abstract

AbstractThis article demonstrates that the market share of a dominant bank and hence, of the associated competitive fringe, namely of the smaller price‐taking banks in the same market, will be stable if fringe size is the same as under perfect competition. One interesting implication of this conclusion is that the empirical evidence about the stability of market shares implies the optimality of the number of small banks in the loan market; it points to what perfect competition entails in practice insofar as the banking system is concerned. It follows that if the fringe is to serve as a transmission channel of monetary policy, a prudential policy targeting the large bank(s) will also be necessary in order to preserve market structure. Analytically, market shares are determined endogenously within a theoretical framework that combines the textbook modelling of dominant firm oligopoly with an inter‐temporal utility for the bank depositor.