Credit Market Competition and Capital Regulation



2(2rRr-rD) < c < RR, and in this range kCS = rc and kreg = RrD +rD --8crr rD). The difference

kreg - kCS simplifies to

(rE - c)rD2 +(R +8c)rErD - 8crE2 =0

The relevant solution is

reD =


rr (R+8c) - 32c2+R2+16c(R+2rr )

2(c- rE)

which implies kreg > kCS only if rD rD.

Proof of Proposition 7: Assume that there is an excess supply of funds so that, as before,
consumer surplus is maximized by setting

rL =


R +(1 — k)c∙D

2


We can substitute this into the equation for q, recalling that cD = rD, and solve for q to
obtain
q1 = 8C ^R + pR2 16crD (1 — k) ´ and q2 = - (R pR2 - 16crD (1 — k) ´. We
focus again on the Pareto dominant equilibrium with a higher level of monitoring (
q1).

We proceed by maximizing CS with respect to the choice of capital, k. However,
we know from above that the combination of
rL = R+(12 k)cD and the highest possible
k will be optimal for borrowers. We therefore introduce the participation constraint for
the bank, that
Π = q(rL — (1 — k)cD) — krEcq2 ≥ 0. Substituting for rL gives q =
8C (R + RR- — 16crd (1 — k) I, and we obtain

Π = cq2 krE = c


fl

8c


П2

krE = 0

Focusing on parameter values for which there is an interior solution for k, the solution is

kCS


1

2c (4геrD )2


R2rE + 2crD2


8crDrE RqrE^R^rE'+ffcrD'—^lβrEcrD).


32




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