How does competition impact bank risk-taking?
AbstractA 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.
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Bibliographic InfoPaper provided by Federal Reserve Bank of San Francisco in its series Working Paper Series with number 2007-23.
Date of creation: 2007
Date of revision:
Other versions of this item:
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-10-27 (All new papers)
- NEP-BAN-2007-10-27 (Banking)
- NEP-COM-2007-10-27 (Industrial Competition)
- NEP-CSE-2007-10-27 (Economics of Strategic Management)
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