A macroeconomic theory of banking oligopoly

Abstract

We study the behavior and macroeconomic impact of oligopolistic banks in a tractable environment with micro-foundations for money and banking. In our model, large banks interact strategically as they compete against each other to make loans. Banks face potential liquidity issues as they try to secure deposits as a source of funds. We find that it is welfare-maximizing to have the banking sector as oligopolistic, i.e., to have a small number of large banks. In addition, inflation stimulates bank entry but always reduces welfare.