Semi Perfect Competition in the Branch Banking Sector: A Microeconomic Model

Abstract

The commercial banking sector in most countries operates in a perfectly competitive market structure due to entry restrictions. Once the free entry and exit assumptions are dropped for the incumbent banks, their behaviors seem to be very close to a perfectly competitive market. Service charges, interest on deposit, interest on corporate and personal loans, etc. are highly competitive. This type of market structure needs a new name. Let's call it a "Semiperfect Competitive Market". Thus, it is useful to develop a microeconomic model of the commercial banking sector assuming that it operates in a semiperfect competitive market. The present paper proposes a slightly modified model of branch banking where the service outputs of the banking sector are assumed to consist of the collection of deposits (D) and providing Loans (L) while the incumbent banks operate in a perfectly competitive market, but there are barriers to the new entry. The paper finds that (1) new issues of treasury bills or bonds by the government decreases in commercial banks' loans and deposits (due to inflation and increased interest rates on loans), (2) If the average reserve coefficient,  (the statutory cash reserve to central bank (R) divided by the deposits held by the commercial banks (D) increases, then the volume of average loans ( will decrease, and the average deposits will increase, and (3) the effect of the increase in loans on the marginal cost of deposits is decreasing due to economies scale resulting from the two simultaneous activities of lending and deposit management.