Loan Market Competition and Bank Risk-Taking
TILEC Discussion Paper No. 2007-010
11 Pages Posted: 31 Mar 2007
Date Written: March 2007
Recent literature (Boyd and De Nicoló, 2005) has argued that competition in the loan market lowers bank risk by reducing the risk-taking incentives of borrowers. We show that the impact of loan market competition on banks is reversed if banks can adjust their loan portfolios. The reason is that when borrowers become safer, banks want to offset the effect on their balance sheet and switch to higher-risk lending. They even overcompensate the effect of safer borrowers because loan market competition erodes their franchise values and thus increases their risk-taking incentives.
Keywords: loan market competition, risk shifting, bank stability
JEL Classification: G21, L11
Suggested Citation: Suggested Citation