Are Transition Countries Overbanked? The Effect of Institutions on Bank Market Entry

The popular notion that transition countries are overbanked is challenged in this paper. We study the decision for market entry and the optimal number of banks in a Salop model. We show that the amount of collateral, which is necessary to solve the moral hazard problem of finance, depends on the distance between bank and firm as well as the quality of the institutional environment. We analyze how the number of banks decreases as the institutional environment improves. Moreover, we find that market entry is insufficient because new entrants do not consider thoroughly the positive effects of their entry decision on social welfare. Copyright Verein für Socialpolitik and Blackwell Publishing Ltd. 2004.