Banking regulation and competition with product differentiation

Abstract

The main motivation for prudential regulation is to increase the solvency of the banking sector. However, it is usually understood that tighter regulation also leads to more concentration and higher spreads. Thus, these prudential measures are seen as implying a trade-off between solvency and competition. In this paper we argue that this trade-off does not necessarily exist. We present a model in which tighter capital requirements lead banks to choose a lower degree of product differentiation, potentially inducing more intense competition and lower spreads. The model is motivated by the recent evolution of the Argentine banking sector.