Equilibrium Features of Imperfect Competition in the Deposit Market of Banking Sector

This paper is an endeavor towards investigating the potential role of deposit market structure as a distinct channel for (monetary, fiscal, and regulatory) policy transmission mechanism. In doing so, we have developed the core idea in a rational expectation partial equilibrium setup incorporating the possibility of contagion risk in the banking system. This has enabled us to build up more sensible analytical findings within a tractable structure which is capable of making diverse equilibria spotted in some empirical evidence. The setup/paper lays down conditions under which one could expect Nash equilibria involving, inter alia, “limited price war”, “deposit rates rat race”, “bank run”, and “systemic banking crisis” followed by incidents of “banking panic”. This multiplicity in equilibria is the result of interaction between the deposit market structural characteristics and policy commands due to externalities originating from strategic complementarity/substitution among the rivalry banks in the market. Further the paper explores the allocation and stabilization efficiency implications in terms of conceivable equilibria for deposit rates, deposit market share, expected net returns, expected markup, and the level of expected effort of banks operating in the banking system with an emphasis on the role of equity capital in between.