Financial liberalization stimulates competition and thereby supposedly increases
the efficiency of investment. A simple credit market model is developed to show that such
efficiency improvements may be disturbed by competition-induced incentives for banks to
accept higher default rates, which result in instability of the financial system. Thereby we
offer a complementary explanation to the relationship between competition and stability in
financial markets. Consequently we argue that government intervention, in the form of
intelligent regulation, is necessary to ensure the development of sustainable financial
markets.
Table of Contents
1. Introduction
2. The Case of Bolivia
3. Theoretical Framework
3.1. Macroeconomic effects of financial liberalization
3.2. Microeconomic effects of domestic financial liberalization
3.3. Research question
4. The Model
4.1. Entrepreneurs
4.2. Banks
4.3. Credit default
4.4. Optimal strategy
5. Discussion
5.1. Heterogeneous banking technologies
5.2. The distribution of the individual cost to default
5.3. Involuntary loan default
5.4. Monitoring
5.5. Provisioning
5.6. Credit Bureaus
5.7. Stylized Facts
5.8. Limitations
6. Conclusion and Policy Recommendations
7. References
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