Is There a Competition-Stability Trade-Off in European Banking?

37 Pages Posted: 14 Jun 2015 Last revised: 7 Jul 2016

Aurélien Leroy

LAREFI, University of Bordeaux

Yannick Lucotte

PSB Paris School of Business

Date Written: July 6, 2016

Abstract

The trade-off between bank competition and financial stability has always been a widely and controversial issue, both among policymakers and academics. This paper empirically re-investigates the relationship between competition and bank risk across a sample of 54 European listed banks over the period 2004-2013. However, in contrast to most extant literature, we consider both individual and systemic dimension of risk. Bank-individual risk is measured by the Z-score and the distance-to-default, while we consider the SRISK as a proxy for bank systemic risk. Using the Lerner index as an inverse measure of competition, our results suggest that competition encourages bank risk-taking and then increases individual bank fragility. This result is in line with the traditional “competition-fragility” view. Our most important findings concern the relationship between competition and systemic risk. Indeed, contrary to our previous results, we find that competition enhances financial stability by decreasing systemic risk. This result can be explained by the fact that weak competition tends to increase the correlation in the risk-taking behavior of banks.

Keywords: Bank competition, Lerner Index, Financial stability, Bank-risk taking, Systemic risk, Competition policy

JEL Classification: G21, G28, G32, L51

Suggested Citation

Leroy, Aurélien and Lucotte, Yannick, Is There a Competition-Stability Trade-Off in European Banking? (July 6, 2016). Available at SSRN: https://ssrn.com/abstract=2617975 or http://dx.doi.org/10.2139/ssrn.2617975

Aurélien Leroy (Contact Author)

LAREFI, University of Bordeaux ( email )

Avenue Léon Duguit
Pessac, Centre 33400
France

Yannick Lucotte

PSB Paris School of Business ( email )

59 rue Nationale
Paris, 75013
France

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