How Does Competition Impact Bank Risk Taking?

EFA 2007 Ljubljana Meetings Paper

FRB of San Francisco Working Paper No. 2007-23

AFA 2008 New Orleans Meetings Paper

37 Pages Posted: 27 Feb 2007  

Jesus Saurina Salas

Banco de España

Gabriel Jiménez

Banco de España

Jose A. Lopez

Federal Reserve Bank of San Francisco

Date Written: September 2007

Abstract

A common assumption in the academic literature and in the actual supervision of banking systems worldwide is that franchise value plays a key role in limiting bank risk-taking. As the underlying source of franchise value is assumed to be market power, reduced competition has been considered to promote banking stability. Boyd and De Nicolo (2005) propose an alternative view where concentration in the loan market could lead to increased borrower debt loads and a corresponding increase in loan defaults that undermine bank stability. Martinez-Miera and Repullo (2007) encompass both approaches by proposing a nonlinear relationship between competition and bank risk-taking. Using unique datasets for the Spanish banking system, we examine the empirical nature of that relationship. After controlling for macroeconomic conditions and bank characteristics, we find that standard measures of market concentration do not affect the ratio of non-performing commercial loans (NPL), our measure of bank risk. However, using Lerner indexes based on bank-specific interest rates, we find a negative relationship between loan market power and bank risk. This result provides evidence in favor of the franchise value paradigm.

Keywords: bank competition, franchise value, Lerner index

JEL Classification: G21, L11

Suggested Citation

Saurina Salas, Jesus and Jiménez, Gabriel and Lopez, Jose A., How Does Competition Impact Bank Risk Taking? (September 2007). EFA 2007 Ljubljana Meetings Paper; FRB of San Francisco Working Paper No. 2007-23; AFA 2008 New Orleans Meetings Paper. Available at SSRN: https://ssrn.com/abstract=965462 or http://dx.doi.org/10.2139/ssrn.965462

Jesus Saurina Salas (Contact Author)

Banco de España ( email )

Madrid 28014
Spain

Gabriel Jimenez

Banco de España ( email )

Alcala 50
Madrid 28014
Spain

Jose Antonio Lopez

Federal Reserve Bank of San Francisco ( email )

101 Market Street
San Francisco, CA 94105
United States
415-977-3894 (Phone)
415-974-2168 (Fax)

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