Foreign Competition and Banking Industry Dynamics: An Application to Mexico

Abstract: We develop a simple general equilibrium framework to study the effects of global competition on banking industry dynamics and welfare. We apply the framework to the Mexican banking industry, which underwent a major structural change in the 1990s as a consequence of both government policy and external shocks. Given high concentration in the Mexican banking industry, domestic and foreign banks act strategically in our framework. After calibrating the model to Mexican data, we examine the welfare consequences of government policies which promote global competition. We find modest welfare gains for households and substantial gains for business.