Does Competition Affect Bank Risk?

Abstract

Although policymakers often discuss tradeoffs between bank competition and stability, past research provides differing theoretical perspectives and empirical results on the impact of competition on risk. In this paper, we employ a new approach for identifying exogenous changes in the competitive pressures facing individual banks and discover that an intensification of competition materially boosts individual and systemic bank risk. With respect to the mechanisms, we find that competition reduces banks’ profits, charter values, and relationship lending and increases banks’ provision of nontraditional banking services and lending to riskier firms.

Keywords: Competition, Bank Risk Taking, Bank Deregulation

JEL Classification: G21, G28, G32, G38