The Effects of Competition on Banks’ Risk Taking with and without Deposit Insurance
AbstractWe consider the joint effect of competition and deposit insurance on risk taking by banks when the riskiness of banks is unobservable to depositors. It turns out that the magnitude of risk taking depends on the type of bank competition. If the bank is a monopoly or banks compete only in the loan market, deposit insurance has no effect on risk taking. In that case the banks are too risky but extreme risk taking is avoided. In contrast, introducing deposit insurance increases risk taking if banks compete for deposits. Then, deposit rates become excessively high and force the banks to take extreme risks. Regarding the effects of increasing competition when there is deposit insurance, the results imply that deposit competition encourages risk taking but loan market competition does not. Our results can be extended more generally to insurance guaranty funds.
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Bibliographic InfoPaper provided by Bank of Finland in its series Research Discussion Papers with number 21/2000.
Length: 25 pages
Date of creation: 18 Dec 2000
Date of revision:
deposit insurance; insurance guaranty funds; bank and insurance regulation; moral hazard; credit rationing; financial fragility;
Find related papers by JEL classification:
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
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