Bank Competition and Financial Stability

27 Pages Posted: 20 Apr 2016

See all articles by Allen N. Berger

Allen N. Berger

University of South Carolina - Darla Moore School of Business; Wharton Financial Institutions Center; European Banking Center

Leora F. Klapper

World Bank; World Bank - Development Research Group (DECRG)

Rima Turk-Ariss

International Monetary Fund; Economic Research Forum

Date Written: August 1, 2008

Abstract

Under the traditional "competition-fragility" view, more bank competition erodes market power, decreases profit margins, and results in reduced franchise value that encourages bank risk taking. Under the alternative "competition-stability" view, more market power in the loan market may result in greater bank risk as the higher interest rates charged to loan customers make it more difficult to repay loans and exacerbate moral hazard and adverse selection problems. But even if market power in the loan market results in riskier loan portfolios, the overall risks of banks need not increase if banks protect their franchise values by increasing their equity capital or engaging in other risk-mitigating techniques. The authors test these theories by regressing measures of loan risk, bank risk, and bank equity capital on several measures of market power, as well as indicators of the business environment, using data for 8,235 banks in 23 developed nations. The results suggest that - consistent with the traditional "competition-fragility" view - banks with a greater degree of market power also have less overall risk exposure. The data also provide some support for one element of the "competition-stability" view - that market power increases loan portfolio risk. The authors show that this risk may be offset in part by higher equity capital ratios.

Keywords: Banks & Banking Reform, Debt Markets, Access to Finance, Markets and Market Access

Suggested Citation

Berger, Allen N. and Klapper, Leora F. and Turk-Ariss, Rima, Bank Competition and Financial Stability (August 1, 2008). World Bank Policy Research Working Paper No. 4696. Available at SSRN: https://ssrn.com/abstract=1243102

Allen N. Berger (Contact Author)

University of South Carolina - Darla Moore School of Business ( email )

1705 College St
Francis M. Hipp Building
Columbia, SC 29208
United States
803-576-8440 (Phone)
803-777-6876 (Fax)

Wharton Financial Institutions Center

Philadelphia, PA 19104-6367
United States

European Banking Center

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Leora F. Klapper

World Bank ( email )

1818 H Street, N.W.
Washington, DC 20433
United States
202-473-8738 (Phone)

HOME PAGE: http://econ.worldbank.org/staff/lklapper

World Bank - Development Research Group (DECRG)

1818 H. Street, N.W.
MSN3-311
Washington, DC 20433
United States

Rima Turk-Ariss

International Monetary Fund ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Economic Research Forum ( email )

21 Al-Sad Al-Aaly St.
(P.O. Box: 12311)
Dokki, Cairo
Egypt

Register to save articles to
your library

Register

Paper statistics

Downloads
1,310
Abstract Views
5,463
rank
14,375
PlumX Metrics