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Market Structure and Risk Taking in the Banking Industry

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Author Info

  • Shy, Oz

    ()
    (Federal Reserve Banks - Federal Reserve Bank of Boston)

  • Stenbacka, Rune

    ()
    (Hanken School of Economics)

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Abstract

This study demonstrates that the common view, whereby an increase in competition leads banks to increased risk taking, fails to hold in an environment where consumers can choose in which bank to make a deposit based on their knowledge of the riskiness incorporated in the banks' outstanding loan portfolios. We show that, in the absence of deposit insurance, competition between differentiated banks will increase the returns from diversification. We offer a welfare analysis establishing that introduction of competition into the banking industry can only improve social welfare. However, competition cannot always guarantee that diversification will occur to a socially optimal extent. Finally, we show that deposit insurance would eliminate the beneficial effects of banks competing with asset quality as a strategic instrument.

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File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/DP_22_1998.pdf
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Bibliographic Info

Paper provided by Bank of Finland in its series Research Discussion Papers with number 22/1998.

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Length: 32 pages
Date of creation: 27 Oct 1998
Date of revision:
Handle: RePEc:hhs:bofrdp:1998_022

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Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
Web page: http://www.suomenpankki.fi/en/
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Related research

Keywords: risk taking in banking; banks' portfolio diversification; bank competition; deposit insurance;

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References

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  1. Matutes, Carmen & Vives, Xavier, 1995. "Imperfect Competition, Risk Taking, and Regulation in Banking," CEPR Discussion Papers 1177, C.E.P.R. Discussion Papers.
  2. Caminal, Ramón & Matutes, Carmen, 1997. "Can Competition in the Credit Market be Excessive?," CEPR Discussion Papers 1725, C.E.P.R. Discussion Papers.
  3. Sudipto Bhattacharya and Dilip Mookherhee., 1984. "Portfolio Choice in Research and Development," Research Program in Finance Working Papers, University of California at Berkeley 147, University of California at Berkeley.
  4. Jappelli, Tullio & Pagano, Marco, 1991. "Information Sharing in Credit Markets," CEPR Discussion Papers 579, C.E.P.R. Discussion Papers.
  5. V. Cerasi & S. Daltung, 1995. "The Optimal Size of a Bank: Costs and Benefits of Diversification," Departmental Working Papers 1995-05, Department of Economics, Management and Quantitative Methods at Università degli Studi di Milano.
  6. Winton, Andrew, 1997. "Competition among Financial Intermediaries When Diversification Matters," Journal of Financial Intermediation, Elsevier, vol. 6(4), pages 307-346, October.
  7. Matutes, Carmen & Vives, Xavier, 1996. "Competition for Deposits, Fragility, and Insurance," Journal of Financial Intermediation, Elsevier, vol. 5(2), pages 184-216, April.
  8. Eduardo Levy Yeyati & Tito Cordella, 1997. "Public Disclosure and Bank Failures," IMF Working Papers 97/96, International Monetary Fund.
  9. Michael H. Riordan, 1992. "Competition and Bank Performance: A Theoretical Perspective," Papers, Boston University - Industry Studies Programme 0026, Boston University - Industry Studies Programme.
  10. Broecker, Thorsten, 1990. "Credit-Worthiness Tests and Interbank Competition," Econometrica, Econometric Society, Econometric Society, vol. 58(2), pages 429-52, March.
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Citations

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Cited by:
  1. Fotios Pasiouras & Chrysovalantis Gaganis & Constantin Zopounidis, 2006. "The impact of bank regulations, supervision, market structure, and bank characteristics on individual bank ratings: A cross-country analysis," Review of Quantitative Finance and Accounting, Springer, vol. 27(4), pages 403-438, December.
  2. Craig, B.R. & Dinger, V., 2010. "Deposit Market Competition, Wholesale Funding, and Bank Risk," Discussion Paper, Tilburg University, Center for Economic Research 2010-65S, Tilburg University, Center for Economic Research.

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