Foreign Competition and Banking Industry Dynamics: An Application to Mexico Pablo D’Erasmo 1 Dean Corbae Univ. of Wisconsin FRB Philadelphia June 12, 2014 1 The views expressed here do not necessarily reflect those of the FRB Philadelphia or The Federal Reserve System.
Objective ◮ We build a general equilibrium model to study the effects of global competition on banking industry dynamics and welfare.
Objective ◮ We build a general equilibrium model to study the effects of global competition on banking industry dynamics and welfare. ◮ We apply the framework to Mexico which underwent major structural changes during 1990’s Question What are the welfare consequences of government policies which promote global competition in highly concentrated banking industries?
Outline 1. Brief description of the Mexican experience.
Outline 1. Brief description of the Mexican experience. 2. A Dynamic Model of the Banking Industry
Outline 1. Brief description of the Mexican experience. 2. A Dynamic Model of the Banking Industry ◮ Underlying Static Strategic Model as in Allen & Gale (2000) embedded in a dynamic model of entry and exit as in Ericson & Pakes (1995).
Outline 1. Brief description of the Mexican experience. 2. A Dynamic Model of the Banking Industry ◮ Underlying Static Strategic Model as in Allen & Gale (2000) embedded in a dynamic model of entry and exit as in Ericson & Pakes (1995). ◮ Dynamic equilibrium allows us to examine how policy changes spill over to the rest of the economy and welfare.
Outline 1. Brief description of the Mexican experience. 2. A Dynamic Model of the Banking Industry ◮ Underlying Static Strategic Model as in Allen & Gale (2000) embedded in a dynamic model of entry and exit as in Ericson & Pakes (1995). ◮ Dynamic equilibrium allows us to examine how policy changes spill over to the rest of the economy and welfare. ◮ Most quantitative macro models (e.g. Diaz-Gimenez, et. al. (1992)) assume perfect competition & CRS → indeterminate size distn.
Outline 1. Brief description of the Mexican experience. 2. A Dynamic Model of the Banking Industry ◮ Underlying Static Strategic Model as in Allen & Gale (2000) embedded in a dynamic model of entry and exit as in Ericson & Pakes (1995). ◮ Dynamic equilibrium allows us to examine how policy changes spill over to the rest of the economy and welfare. ◮ Most quantitative macro models (e.g. Diaz-Gimenez, et. al. (1992)) assume perfect competition & CRS → indeterminate size distn. 3. Calibration using averages of Mexican bank industry data.
Outline 1. Brief description of the Mexican experience. 2. A Dynamic Model of the Banking Industry ◮ Underlying Static Strategic Model as in Allen & Gale (2000) embedded in a dynamic model of entry and exit as in Ericson & Pakes (1995). ◮ Dynamic equilibrium allows us to examine how policy changes spill over to the rest of the economy and welfare. ◮ Most quantitative macro models (e.g. Diaz-Gimenez, et. al. (1992)) assume perfect competition & CRS → indeterminate size distn. 3. Calibration using averages of Mexican bank industry data. 4. Tests: Crisis/default - Concentration; Business cycle correlations
Outline 1. Brief description of the Mexican experience. 2. A Dynamic Model of the Banking Industry ◮ Underlying Static Strategic Model as in Allen & Gale (2000) embedded in a dynamic model of entry and exit as in Ericson & Pakes (1995). ◮ Dynamic equilibrium allows us to examine how policy changes spill over to the rest of the economy and welfare. ◮ Most quantitative macro models (e.g. Diaz-Gimenez, et. al. (1992)) assume perfect competition & CRS → indeterminate size distn. 3. Calibration using averages of Mexican bank industry data. 4. Tests: Crisis/default - Concentration; Business cycle correlations 5. Counterfactual: Foreign Bank Competition ( ↑ Υ f ).
The Mexican Experience ◮ External events and government policy interacted to generate wide swings in market share and ownership structure in Mexico’s banking system. ◮ In 1982, following an oil price shock which brought on a major economic crisis (GDP declined by 4.7%), Mexico nationalized 58 of its 60 existing banks. ◮ The number of commercial banks was reduced to 29 in 1983 and in 1990, when the process of full re-privatization started, only 18 of these remained active. ◮ Foreign banks were not allowed to buy Mexican banks with market share greater of 1.5%.
The Mexican Experience (cont.) ◮ The Mexican tequila crisis in 1994 resulted in a large increase in non-performing loans. ◮ Bank insolvency associated with this episode was estimated to cost Mexican taxpayers 19.3% of GDP. ◮ The crisis and the start of NAFTA, induced the Mexican government to gradually remove restrictions on foreign participation. ◮ Foreign participation rose from 5.5% in 1993 to 55% in 2000 to 80% in 2002.
Foreign Bank Participation 0.9 Loan 0.85 Assets 0.8 0.75 Foreign Market Share 0.7 0.65 0.6 0.55 0.5 0.45 0.4 1998 2000 2002 2004 2006 2008 2010 2012 year
Model Overview ◮ Banks intermediate between unit-measure infinitely lived ◮ risk averse households who can deposit at a bank with deposit insurance ◮ risk neutral borrowers who demand funds to undertake iid risky projects. ◮ By lending to a large number of borrowers, a given bank diversifies risk that any particular household cannot accomplish individually. ◮ Simple bank balance sheet (assets=private loans, liablities=deposits+equity). Corbae and D’Erasmo (2012) adds securities and bank borrowing. ◮ Dynamic strategic (Cournot competition) MPE in the loan market between domestic and foreign banks. ◮ A nontrivial size distribution of banks arises out of entry/exit in response to domestic and global shocks.
Households ◮ Unit mass of infinitely period lived ex-ante identical households ◮ Preferences � ∞ � � β t u ( C t ) E t =0 ◮ Endowed with one unit of a perishable good at the beginning of each period ◮ Have access to a risk-free short term storage technology a t ≥ 0 with return ( 1 + ¯ r ). ◮ They can also deposit d t ≥ 0 in a bank with return ( 1 + r d ). There is deposit insurance. ◮ Households hold divisible shares of banks S t +1 that are traded at the end of the period at price P t . ◮ Households pay lump sum taxes τ t to pay for deposit insurance.
Entrepreneurs ◮ Unit mass of infinitely period lived ex-ante identical and risk neutral entrepreneurs. ◮ Demand one unit bank loans in order to fund a project at start of t . There is inter-period anonymity, so loan contracts are one period long. ◮ Borrowers choose the return of the project R t and have limited liability. Borrower chooses R Receive Pay Probability − + ���� ���� 1 + r L Success 1 + z t +1 R t p ( z t +1 ) R t , t Failure 1 − λ 1 − λ 1 − p ( R t , z t +1 ) ◮ Borrowers have an outside option (reservation utility) ω t ∈ [ ω, ω ] drawn at start of t from distribution Ω( ω t ) .
Stochastic Processes ◮ Aggregate domestic technology shocks z t +1 ∈ { z c , z b , z g } follow a Markov Process F ( z t +1 , z | η t +1 ) with z c < z b < z g ◮ Worldwide shocks η t +1 ∈ { η L , η H } also follow a Markov Process, G ( η t +1 , η t ) . ◮ Conditional on z t +1 , borrower failure is iid across individuals and drawn from p ( R t , z t +1 ) .
Banks ◮ Two types of banks θ ∈ { n, f } for national and foreign. ◮ Banks maximize expected discounted sum of dividends �� � M t D θ E t t =0 ◮ Entry costs to create national and foreign banks are denoted Υ f ≥ Υ n ≥ 0 ◮ Banks serve the domestic loan market. Loans made by bank θ denoted ℓ θ ◮ Bank’s feasibility constraint d θ ≥ ℓ θ ◮ Net and fixed operating costs: ( c θ , κ θ ) , c θ = ˜ c θ + ¯ c θ (1 − p ( R t , z t +1 ))
Bank Profits / Dividends-Exit Policies ◮ End-of-period profits for bank of type ( θ ) are: � t ) + (1 − p ( R t , z t +1 ))(1 − λ ) − c θ � π θ p ( R t , z t +1 )(1 + r L ℓ θ t = t − (1 + r D ) d θ t − κ θ . ◮ Banks have access to outside funding (or equity financing) at cost ξ θ ( x, η t +1 ) per units of funds raised in state η t +1 . ◮ National banks has no uncertainty about funding cost ξ n ( x, η t +1 ) = ξ n ( x ) and η L < 1 < η H ◮ Bank dividends at the end of the period are � π θ if π θ t ≥ 0 D θ t t = (1) π θ t (1 + ξ θ ( − π θ if π θ t , η t +1 )) t < 0 ◮ Banks choose to exit with exit value max { π t , 0 } (i.e., limited liab.)
Industry State ◮ The industry state is denoted µ t = { µ t ( n ) , µ t ( f ) } , where each element of µ t is a counting measure µ t ( θ ) corresponding to active banks of type θ ◮ Denote aggregate state s = { z, η } Information Timing Def. Equilibrium
Independent Model Parameters Parameter Value Target Dep. preferences σ 2.00 standard value Agg. shock in good state z g 1.00 normalization Deposit interest rate (%) r ¯ 1.94 cost deposits c n Net. non-int. exp. f bank ˜ 2.02 net non-interest expense c r Net. non-int. exp. n bank ˜ 2.41 net non-interest expense Functional Forms
Recommend
More recommend
