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Deposit competition and loan markets

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  • Arping, Stefan

Abstract

Less-intense competition for deposits, by mitigating banks’ incentive to take excessive risks, is traditionally believed to lead to lower non-performing loan (NPL) ratios and more-stable banks. This paper revisits this proposition in a model with borrower moral hazard in which banks’ NPL ratios depend endogenously on their loan pricing. In relatively uncompetitive loan markets, less-fierce competition for deposits (i.e., lower deposit rates) leads to lower loan rates and, thus, safer loans. In more-competitive markets, the opposite can occur: As banks’ deposit-repayment burdens decline, they become less eager to risk-shift; this softens competition for risky loans, leading to higher loan rates and, ultimately, riskier loans. Overall, the model predicts a hump-shaped relationship between banks’ pricing power in deposit markets and their NPL ratios.

Suggested Citation

  • Arping, Stefan, 2017. "Deposit competition and loan markets," Journal of Banking & Finance, Elsevier, vol. 80(C), pages 108-118.
    • Handle: RePEc:eee:jbfina:v:80:y:2017:i:c:p:108-118
    DOI: 10.1016/j.jbankfin.2017.04.006
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    Cited by:

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    2. Khattak, Mudeer Ahmed & Ali, Mohsin & Azmi, Wajahat & Rizvi, Syed Aun R., 2023. "Digital transformation, diversification and stability: What do we know about banks?," Economic Analysis and Policy, Elsevier, vol. 78(C), pages 122-132.
    3. Yoshiaki Ogura, 2019. "Search-for-Yield under Prolonged Monetary Easing and Aging," Working Papers e142, Tokyo Center for Economic Research.
    4. Elena Deryugina & Alexey Ponomarenko & Andrey Sinyakov, 2021. "Exploring the conjunction between the structures of deposit and credit markets in the digital economy under information asymmetry," Bank of Russia Working Paper Series wps78, Bank of Russia.
    5. Fukuyama, Hirofumi & Matousek, Roman & Tzeremes, Nickolaos G., 2022. "Bank production with nonperforming loans: A minimum distance directional slack inefficiency approach," Omega, Elsevier, vol. 113(C).
    6. Rafik Harkati & Syed Musa Alhabshi & Salina Kassim & Noraini Mohd Ariffin, 2022. "Market structure and power: comparative empirical evidence from a dual banking system," Economic Change and Restructuring, Springer, vol. 55(3), pages 1815-1873, August.

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    More about this item

    Keywords

    Bank competition; Loan pricing; Financial stability;
    All these keywords.

    JEL classification:

    • G2 - Financial Economics - - Financial Institutions and Services
    • G3 - Financial Economics - - Corporate Finance and Governance
    • L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance
    • L3 - Industrial Organization - - Nonprofit Organizations and Public Enterprise

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