Banking Industry: Structure and Competition - Financial innovation and growth of shadow banking system - Avoidance of existing regulations

5 important questions on Banking Industry: Structure and Competition - Financial innovation and growth of shadow banking system - Avoidance of existing regulations

What did government regulation on the financial industry lead to?

Leads to financial innovation by creating incentives for firms to avoid regulations that restrict the ability to earn profits: ‘loophole mining’

What happened on the liability side of the 1970s?

Disintermediation: depositors were finding homes for their funds outside of the banking system, because traditionally they did not
receive interest on deposits

What happened to the banks in the late 70s when they began to pay interest to obtain funds?

the cost of acquiring funds had risen substantially, reducing the cost advantage over
other financial institutions
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What happened on the asset side?

Decline in income advantage of banks due to junk bonds, securitization and the rise of commercial paper

Firms were able to acquire funds trough the financial market and didn't rely on banks to the same extent, how did the bank respond?

- Decline in profitability usually results in an exit from the industry and shrinkage of market share. European banking industry actually
consolidated.
To survive banks attempted to maintain their traditional lending activity by expanding to new and riskier areas of lending

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