11wherez>1 is the elasticity of sub

11wherez>1 is the elasticity of substitution between differentiated loans (or banking services,in general). Demand by consumeriseeking a real amount of loans equal tobi;tcan be derivedby minimizing the total repayment due to the continuum of banksjoverbij;t. Aggregating oversymmetric households, this minimization problem yields downward-sloping loans demand curvesof the kind:bj;t=RLj;tRLtzbt:(8)with the aggregate interest rate on loans given by:RLt=Z10R1zLj;td j11z:(9)B BANKS AND LOAN SUPPLYThere is a continuum of monopolistically competitive domestic banks indexed byj2[0;1]ownedby households. Microeconomic theory typically considers market power as a distinctive featureof the banking sector (Freixas and Rochet, 2008).7In particular, we assume that each bankjsup-plies slightly differentiated financial products, and no other bank produces the same variety: eachbank has, therefore, some monopoly power over its product. However, each bank competes withall other banks, since consumers consider each bank’s variety as imperfect substitutes. As bankshave market power over the supply of their variety, they set prices to maximize profits, taking intoaccount the elasticity of demand for their variety.Each bankjcollects fully insured depositsdj;tfrom foreign investors at the risk-free interest rateRt=R, whereRis exogenous and given. We further assume that foreign lenders have an in-finite supply of deposits, so that banks can satisfy any demand for loans. Finally, banks use de-posits to supply loans to consumers with the following constant return to scale production func-tion:bj;t=dj;t:(10)