[...]... business, or finance What Is New in the Second Edition? Since the publication of the first edition of this book, the development of academic research on the microeconomics of banking has been spectacular This second edition attempts to cover most of the publications that are representative of these new developments Three topics are worth mentioning xviii Preface First, the analysis of competition between banks... cover both the management of clients’ accounts and the finality of payments, that is, the guarantee by the bank that the debt of the payor (who has received the goods or services involved in the transaction) has been settled to the payee through a transfer of money 1.2.1 Money Changing Historically, the first activity of banks was money changing This is illustrated by the etymology of the word: the Greek... expensive sources of funds As a consequence, the bank will have to manage the combination of interest rate risk (due to the di¤erence in maturity) and liquidity risk (due to the di¤erence in the marketability of the claims issued and that of the claims held) The management of interest rate risk has become crucial for banks since the increase in the volatility of interest rates after the end of the Bretton-Woods... through other strategic variables than interest rates or service fees For example, banks compete on the level of the asset risk they take or the intensity of the monitoring of borrowers These dimensions are crucial for shedding light on two important issues: the competitionstability trade-o¤ and the e¤ect of entry of new banks, both of concern for prudential regulation Second, the literature on the macroeconomic... activity of these firms For theoretical analyses of trade credit, see Biais and Gollier (1997) and Kiyotaki and Moore (1997) 2 Consider, for example, the title of the article by Gorton and Pennacchi (1993): ‘‘Money Market Funds and Finance Companies: Are They the Banks of the Future?’’ 3 The main reason is the famous argument of ‘‘double coincidence of wants’’ between traders 4 For a theoretical analysis of. .. parallel development of economic modeling Prerequisites This book focuses on the theoretical aspects of banking Preliminary knowledge of the institutional aspects of banking, taught in undergraduate courses on money and banking, is therefore useful Good references are the textbooks of Mishkin (1992) or Garber and Weisbrod (1992) An excellent transition between these textbooks and the theoretical material... macroeconomic impact of the financial structure of firms has made significant progress on at least two questions: the transmission of monetary policy and the e¤ect of capital requirements for banks on the functioning of the credit market Finally, the theoretical foundations of banking regulation have been clarified, even though the recent developments in risk modeling (due in particular to the new Basel accords... 8.5.2 The Risk Structure of Interest Rates 8.5.3 Using the CAPM for Loan Pricing 8.6 Solutions 8.6.1 The Model of Prisman, Slovin, and Sushka 8.6.2 The Risk Structure of Interest Rates 8.6.3 Using the CAPM for Loan Pricing 265 266 266 267 271 273 274 275 277 280 281 283 284 286 286 The Regulation of Banks 9.1 The Justification for Banking Regulation 9.1.1 The General Setting 9.1.2 The Fragility of Banks... explaining the role of banks in the economy and pointing out the structural weaknesses of the banking sector (exposure to runs and panics, persistence of rationing on the credit market, recurrent solvency problems) that may justify public intervention This book provides a guide to this new microeconomic theory of banking It focuses on the main issues and provides the necessary tools to understand how they... through the deposits of the public This is the main explanation for the fragility of the banking sector and the justification for banking regulation Some economists predict that commercial banks o¤ering both loan and deposit transactions will someday disappear in favor of two types of specialized institutions,2 on the one hand ‘‘narrow’’ banks or mutual funds, which invest the deposits of the public in traded . New in the Second Edition? Since the publication of the first edition of this book, the development of academic research on the microec onomics of banking has been spectacular. This second edition attempts. Figures Preface During the last three decades, the economic theory of banking has entered a process of change that has overturned economists’ traditional view of the banking sector. Be- fore that, the banking. w0 h0" alt="" Microeconomics of Banking Microeconomics of Banking Second Edition Xavier Freixas and Jean-Charles Rochet The MIT Press Cambridge, Massachusetts London, England 6 2008 Massachusetts