Less competitive bank markets: Conventional and unconventional monetary policies through bank-lending channels

Abstract

Bank competition in Japan is weakening. This study theoretically analyzes the supply side of the bank loan market to examine how this weak banking competition influences the effectiveness of monetary policies. In a Cournot game, there are efficient banks, and inefficient banks that must pay a risk premium in the call market. Less competitive banks either go out of business or merge with efficient banks. The call rate and risk premium are central banks’ policy instruments. This paper's main finding is that, with a few exceptions, the weak competition reduces the effectiveness of monetary policies because concentration decreases the volume of bank loans. However, concentration makes monetary policy via a reduced risk premium more effective when this policy targets inefficient banks that do not exit or merge. In response to lending declines by efficient banks when they exit or merge, inefficient banks increase their lending activity.