Banks as ‘fat cats’: Branching and Price Decisions in a Two-Stage Model of Competition

In this paper we develop an empirical two-stage model of competition for the banking industry that incorporates the choice of capacity in the form of new branches. It is estimated using data on Italian banks for the years 1995-2009. The results show that the conduct of banks is significantly more competitive than a Bertrand-Nash equilibrium, and support the rejection of the simple one-stage specification, which underestimates the degree of competition. In the Fudenberg and Tirole (1984)’s taxonomy, banks are found to behave as ‘fat cats’, overinvesting in the branch network so as to keep prices high and accommodate entry.