Please answer this question and subparts. Competition is usually considered a net benefit to the economy...

Please answer this question and subparts.

Competition is usually considered a net benefit to the economy as a whole but in the realm of banking that is not necessarily the case.

a. Choose one benefit and one disadvantage from decreasing the competition between banks in an economy. Explain your reasoning.

b. Why has the number of bank holding companies dramatically increased?

Expert Solution

a) Benefit: Decreased competition in the bankingsector can have a distinct benefit of beter financial regulation within an economy. Competition, at times, leads to risky lending practices as financial institutions (propective lenders) search for higher margins. The increase in subprime lending is an example of such behavior prior to the recent financial crisis. On the other hand, higher competition also erodes banks’ profit margins and leaves them without sufficient capital cushions, something that also played a role in the recent financial crisis.

Disadvantage: The biggest disadvantage to decreasing the competition between banks in the economy could be referenced to the 'financial crisis' of 2007-08. As banks were deemed 'too big to fail'. The collapse of the investment bank Lehman Brothers in 2008 wherein their extreme risk-taking led to bankruptcy. This increased the financial crisis impact on the economy and so huge bail-outs were made to prevent more harm being done. Competition is the best way to help avoid this happening again. If there are lots of smaller banks (online as well) offering great services, it becomes unlikely people will only bank with major firms. Banks would thereby take fewer risks as they know they won’t be bailed out in a crisis, as their failure would only have a minor impact on the economy.

b) Though the aftermath of recent financial crisis has seen high regulatory measures imposed on holding companies, additional corporate governance coupled with flexibility in strategic transactions, activities, and investments has made it attractive for bank holding companies. This has resulted in increase in bank holding companies.

jeff jeffy answered 2 years ago

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