Foreign Competition and Banking Industry Dynamics: An Application to Mexico

Abstract

We develop a simple general equilibrium framework to study the effects of global competition on banking industry dynamics and welfare. We apply the framework to the Mexican banking industry, which underwent a major structural change in the 1990s as a consequence of both government policy and external shocks. Given high concentration in the Mexican banking industry, domestic and foreign banks act strategically in our framework. After calibrating the model to Mexican data, we examine the welfare consequences of government policies which promote global competition. We find modest welfare gains for households and substantial gains for business.

Does Competition Affect Bank Risk?

“…Economic theory offers differing perspectives on whether competition increases or decreases bank risk. The competition‐fragility view holds that an intensification of competition reduces bank profit margins and charter values, encouraging banks to increase risk (e.g., Keeley 1990, Hellmann, Murdock, and Stiglitz 2000, Demirguc‐Kunt and Detragiache 2002, Corbae and D'Erasmo 2011, 2015, 2018). Related research explains that competition can curtail the ability of banks to earn information rents from relationship lending (Petersen and Rajan 1995), reducing their incentives to screen and monitor borrowers with adverse effects on bank stability and market efficiency (e.g., Berger et al.…”