We consider a DSGE model with monopolistically competitive banks together with endogenous firms' entry. We find that our model implies higher volatilities of both real and financial variables than those implied by a dynamic stochastic general equilibrium (DSGE) model with a monopolistic banking sector and a fixed number of firms. The response of the economic activity is also more persistent in response to all shocks. Furthermore, we show that inefficient banks enhance the endogenous propagation of the shocks with respect to a model where banks compete under perfect competition and can fully ensure against the risk of firms' default.