On equilibria in the model of deposit markets with exogenous switching costs of depositors
Aldokhin D., Belyakov A., Deryugina E., Ponomarenko A.
Applied research shows that larger banks offer lower deposit rates. To explain this phenomenon, the authors developed a simplified theoretical model of the deposit market. In this model, the only reason for the difference in deposit rates among banks is the switching costs for depositors between these banks. These costs may depend both on the individual characteristics of depositors and on the terms of the banks where the deposits are held.
The proposed theoretical model posits that commercial banks compete through deposit rates, while depositors face fixed switching costs when changing banks. These costs may stem from either informational asymmetries regarding other banks' terms or transaction fees for fund transfers.
The model analysis demonstrates that asymmetric equilibria with heterogeneous deposit rates across banks persist under virtually all switching cost configurations. The inverse correlation between bank size and its weighted average deposit rate may be attributable to structural path dependencies in banking market evolution. Earlier-established banks could have attracted many depositors with high switching costs, while leaving depositors with low switching costs to newly formed banks. As a result, older banks can set lower deposit rates without fearing that their customers will switch to competitors, allowing them to maintain a larger market share of depositors.
Artificially low deposit rates could potentially impede the mechanism of transmission of monetary policy to deposit rates. Banks with a large share of depositors facing high switching costs may be less responsive to regulatory signals, adjusting deposit rates less aggressively.
The theoretical analysis suggests that breaking up large banks into smaller ones would not succeed. On the contrary, it may even worsen the situation for depositors facing high switching costs.
The authors conclude that reducing switching costs could incentivize banks to raise deposit rates due to the increased risk of losing customers. Moreover, this should lead to an improvement in overall social welfare.