How Does Bank Competition Affect Systemic Stability?
Virginia Tech Pamplin Business School; World Bank - Financial and Private Sector Development
World Bank - Financial and Private Sector Development; World Bank
City University of Hong Kong (CityUHK); World Bank - Development Research Group; University of Michigan, Stephen M. Ross School of Business
February 1, 2012
World Bank Policy Research Working Paper No. 5981
Using bank level measures of competition and co-dependence, the authors show a robust positive relationship between bank competition and systemic stability. Whereas much of the extant literature has focused on the relationship between competition and the absolute level of risk of individual banks, in this paper we examine the correlation in the risk taking behavior of banks, hence systemic risk. The analysis finds that greater competition encourages banks to take on more diversified risks, making the banking system less fragile to shocks. Examining the impact of the institutional and regulatory environment on systemic stability shows that banking systems are more fragile in countries with weak supervision and private monitoring, high government ownership of banks, and in countries with public policies that restrict competition. Furthermore, lack of competition has a greater adverse effect on systemic stability in countries with generous safety nets and weak supervision.
Number of Pages in PDF File: 41
Keywords: Banks & Banking Reform, Access to Finance, Debt Markets, Financial Intermediation, Emerging Marketsworking papers series
Date posted: March 1, 2012
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