Optimal capacity in the banking sector and economic growth

The paper investigates, from the welfare and growth point of view, the determination of the optimal capacity of the banking system. For that purpose, we consider an overlapping generation model with endogenous growth. There is horizontal differentiation and imperfect competition in the banking sector. Macro-economic shocks affect the return on capital and, together with the expectations of depositors, condition the stability of the banking sector. We specify to what extent deposit insurance may reduce instability and increase the number of deposits, welfare and growth. We also characterise the conditions under which excess banking capacities may appear and how their reduction may improve welfare. (C) 2002 Elsevier Science B.V. All rights reserved.