Does Competition Reduce the Risk of Bank Failure?

34 Pages Posted: 9 Jun 2008

See all articles by David Martinez-Miera

David Martinez-Miera

Universidad Carlos III de Madrid - Department of Business Administration; Center for Economic Policy Research

Rafael Repullo

Centre for Monetary and Financial Studies (CEMFI); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Multiple version iconThere are 2 versions of this paper

Date Written: January 2008

Abstract

A large theoretical literature shows that competition reduces banks' franchise values and induces them to take more risk. Recent research contradicts this result: When banks charge lower rates, their borrowers have an incentive to choose safer investments, so they will in turn be safer. However, this argument does not take into account the fact that lower rates also reduce the banks' revenues from non-defaulting loans. This paper shows that when this effect is taken into account, a U-shaped relationship between competition and the risk of bank failure generally obtains.

Keywords: Bank competition, Bank failure, Credit risk, Default correlation, Franchise values, Loan defaults, Loan rates, Moral hazard, Net interest income, Risk-shifting

JEL Classification: D43, E43, G21

Suggested Citation

Martinez, David and Repullo, Rafael, Does Competition Reduce the Risk of Bank Failure? (January 2008). CEPR Discussion Paper No. DP6669. Available at SSRN: https://ssrn.com/abstract=1140951

David Martinez

Universidad Carlos III de Madrid - Department of Business Administration ( email )

Calle Madrid 126
Getafe, Madrid, Madrid 28903
Spain

Center for Economic Policy Research ( email )

London
United Kingdom

Rafael Repullo (Contact Author)

Centre for Monetary and Financial Studies (CEMFI) ( email )

Casado del Alisal 5
28014 Madrid
Spain
+34 91429 0551 (Phone)
+34 91429 1056 (Fax)

HOME PAGE: http://www.cemfi.es/~repullo/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Register to save articles to
your library

Register

Paper statistics

Downloads
7
Abstract Views
1,080
PlumX Metrics