On the Relationship between Market Power and Bank Risk Taking
AbstractWe analyse risk-taking behaviour of banks in the context of spatial competition. Banks mobilise unsecured deposits by offering deposit rates, which they invest either in a prudent or a gambling asset. Limited liability along with high return of a successful gamble induce moral hazard at the bank level. We show that when the market power is low, banks invest in the gambling asset. On the other hand, for sufficiently high levels of market power, all banks choose the prudent asset to invest in. We further show that a merger of two neighboring banks increases the likelihood of prudent behaviour. Finally, introduction of a deposit insurance scheme exacerbates banks’ moral hazard problem.
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Bibliographic InfoPaper provided by Edinburgh School of Economics, University of Edinburgh in its series ESE Discussion Papers with number 187.
Date of creation: Feb 2009
Date of revision:
Other versions of this item:
- Kaniska Dam & Marc Escrihuela-Villar & Santiago Sánchez Pages, 2009. "On the Relationship between Market Power and Bank Risk Taking," Working papers DTE 459, CIDE, División de Economía.
- Dam, Kaniska & Escrihuela-Villar, Marc & Sánchez-Pagés, Santiago, 2008. "On the Relationship between Market Power and Bank Risk Taking," SIRE Discussion Papers 2008-26, Scottish Institute for Research in Economics (SIRE).
- D43 - Microeconomics - - Market Structure and Pricing - - - Oligopoly and Other Forms of Market Imperfection
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
- G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-02-28 (All new papers)
- NEP-BAN-2009-02-28 (Banking)
- NEP-BEC-2009-02-28 (Business Economics)
- NEP-COM-2009-02-28 (Industrial Competition)
- NEP-CTA-2009-02-28 (Contract Theory & Applications)
- NEP-IAS-2009-02-28 (Insurance Economics)
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