Market Structure and Risk Taking in the Banking Industry
AbstractThis 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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Bibliographic InfoPaper provided by Bank of Finland in its series Research Discussion Papers with number 22/1998.
Length: 32 pages
Date of creation: 27 Oct 1998
Date of revision:
risk taking in banking; banks' portfolio diversification; bank competition; deposit insurance;
Other versions of this item:
- Oz Shy & Rune Stenbacka, 2004. "Market Structure and Risk Taking in the Banking Industry," Journal of Economics, Springer, vol. 82(3), pages 249-280, 07.
- E53 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Deposit Insurance
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
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