Banking Deregulation: Allocational Consequences of Relaxing Entry Barriers

We present an equilibrium analysis to predict the long-run allocational consequences and risk implications of banking deregulation. Loan demand and deposit supply functions are derived from primitive assumptions about the preferences of individuals, and banks are viewed as (differentiated) competitors in a spatial context. We find that a relaxation of entry barriers into banking improves the welfare of borrowers and savers at the expense of bank stockholders. Equilibrium loan interest rates fall and equilibrium deposit interest rates rise as banking becomes more competitive. Despite this, the equilibrium debt-equity ratios of banks increase as entry barriers are relaxed. We also examine the implications of capital standards and find that an increase in the minimum capital requirement benefits borrowers but hurts depositors.