Bank Market Power Rents and Risk: Theory and Measurement
32 Pages Posted: 14 Jul 2010 Last revised: 20 Nov 2010
Date Written: 2010
This paper presents new measures of market power rents in loan and deposit markets and examines their impact on bank risk-taking. These new measures are derived from optimality conditions common to a wide variety of theoretical models of banks operating under uncertainty and choosing their risk profile. We estimate loan and deposit market power rents using two large European panel datasets of bank consolidated and unconsolidated accounts.
Three main results obtain. First, bank loan and deposit rents are significant and highly positively correlated both at a consolidated and unconsolidated level. Second, larger bank loan and deposit rents predict higher probabilities of bank failures and lower bank capitalization. Third, the quest for market power rents is an important driver for bank consolidation.
These results are consistent with the absence of a trade-off between competition and stability, as well as with market power rents being an important driver of bank consolidation and increased systemic risk.
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