1. SIMPOSIO ANÁLISIS ECONÓMICO ZARAGOZA, 11-13 DIC. 2009
Banking Deregulation, Banking Development and Endogenous Growth
Diego Romero-Ávila
Universidad Pablo de Olavide

2. OBJECTIVE
1)To show the relationship between banking deregulation, banking development and endogenous growth.
2) To highlight the real benefits from banking deregulation in a context of monopolistic competition in the banking market.

3. Empirical Background
1)Jayaratne and Strahan (1996) find that banking deregulation in the form of relaxing bank branch restrictions in the US increased efficiency and growth.
2) Romero-Ávila (2007, 2009) find that banking harmonisation and interest rate deregulation also increased efficiency and growth.

4. Theoretical Framework
We adopt a standard knowledge-driven endogenous growth model a la Grossman and Helpman (1991) which assumes a vertically integrated real economy with three sectors: final good firms, intermediate good firms and research firms.

5. Main Features of the Model
Household Sector
Infinitely-live agents.
Logarithmic UF
Households supply a fixed amount of HK into intermediate goods and banking sectors. So there is no schooling sector as in Arnold (1998).

6. Main Features of the Model
The real economy consists of three sectors vertically integrated.
The technology is CES-type
with equal share for all x(i)
n is the range of intermediate goods and represents the stock of knowledge.
Consumption (Final) Good Sector

7. Main Features of the Model
Intermediate Goods Sector
Produces x(i) using human capital with a linear technology:
Each firm needs to buy a brand or idea (entry cost) in order to operate.
This allows firms to enjoy market power over its differentiated good (Monop. Competition).

8. Main Features of the Model
Research Sector
Research firms use financial resources provided by banks (F) and the stock of knowlegde via externality (n) to generate ideas: , (0,1).
Number of R&D projects financed equals M, so for a given loan size: F=ML.

9. Main Features of the Model
Banking Sector
Monopolistically competitive agents.
Tasks: 1) Maturity transformation, 2) Evaluation of R&D projects and 3) financing those R&D firms with good prospects.
Each bank j maximises subject to the balance sheet equilibrium L=d and the demand for loans.
. This renders
We assume N banks operating at any t and only M are succesful in finding and funding a good project (M successful projects). So M is the stock of knowledge created from the evaluation of succesful R&D projects.
The total HK employed in banking is Each bank assumes an entry cost in the form of HK.

10. Main Features of the Model
Banking Sector Technology: Deregulated Regime
Technology is a concave function of the stock of knowledge in banking M and the HK employed per each bank:
This can be also seen as the probability that a bank finds an R&D firm for which to provide funding.
represents the efficiency units of input.
At the aggregate level,

11. Main Features of the Model
Banking Sector Technology: Regulated Regime
We assume that the presence of the externality in the banking technology captures the positive effect of banking deregulation on the efficiency with which banks gather information and evaluate potential start-ups.
So in a regulated regime where banks cannot share such information, the externality does not exist, and efficiency is only a function of HK.

12. Solution to the model. Steady State results: Deregulated Regime
From the optimisation program for each of the N banks
we find that is constant.
This together with the solution of the optimisation program of manufacturing and research firms, and consumers, which are standard in this literature, we obtain

13. Solution to the model. That condition implies the following:
1) The greater the number of banks gathering information about potential start-ups (N), the greater the number of R&D projects successfully evaluated and financed (M) and the greater the supply of funds to research (F).
2) For a fixed amount of human capital ( ), if N increases, must decrease, thus reducing efficiency. However, if N increases, M does so, which offsets the previous effect, thus leaving banking efficiency
unchanged.
3) Intensified competition among banks leads to progressively close the wedge between the deposit rate (which is given) and the loan rate.

14. Solution to the model From the law of motion of M, we have:
, where m is the ratio of the potential flow of R&D projects to be evaluated and financed relative to the stock of existing R&D projects.
So the steady state growth rate equals:

15. Main Features of the Model
Regulated Regime
In this regime the following steady state condition applies:
and
In this case, which is unique. Since the aggregate supply of HK is given, and there is no longer an information externality in the banking technology now each bank would have to reduce their HK individually if a new bank entered the industry, thus reducing banking efficiency. This is no longer compensated with the information externality as occurs in the other scenario. So no new banks enter the industry.

16. Solution to the model
Thus the deregulation of the banking industry, which we capture through an externality, conditions the development and expansion of the banking sector and in turn the development of the three sectors of the real economy.
So if no more banks enter the industry, no more R&D firms can be evaluated and financed, and the research sector stops producing new ideas, which in turn affects the intermediate goods sectors which cannot expand, and also the consumption goods sector which does not experienced increases in factor-saving productivity.

17. Policy Implications
Our findings appear to back up empirical findings Jayaratne and Strahan (1996) and Romero-Ávila (2007, 2009) who find significant positive growth effects from banking deregulation.
So policymakers should make the effort to deregulate their banking sectors so that real benefits can be reaped from the integration of financial systems, which provide advantages in terms of capital costs and the volume of funds available.

18. Conclusions
1) Banking deregulation leads to greater banking activity through the entry of more banks, which in turn leads to more R&D activity by evaluating and funding more research firms.
2)Banking development by itself, if it is not accompanied by banking deregulation, does not have any effect on the growth of the real economy.