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Bank Risk-Taking and Competition Revisited

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  • Gianni De Nicoló
  • Abu M. Jalal
  • John H. Boyd
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    Abstract

    This paper studies two new models in which banks face a non-trivial asset allocation decision. The first model (CVH) predicts a negative relationship between banks'' risk of failure and concentration, indicating a trade-off between competition and stability. The second model (BDN) predicts a positive relationship, suggesting no such trade-off exists. Both models can predict a negative relationship between concentration and bank loan-to-asset ratios, and a nonmonotonic relationship between bank concentration and profitability. We explore these predictions empirically using a cross-sectional sample of about 2,500 U.S. banks in 2003 and a panel data set of about 2,600 banks in 134 nonindustrialized countries for 1993-2004. In both these samples, we find that banks'' probability of failure is positively and significantly related to concentration, loan-to-asset ratios are negatively and significantly related to concentration, and bank profits are positively and significantly related to concentration. Thus, the risk predictions of the CVH model are rejected, those of the BDN model are not, there is no trade-off between bank competition and stability, and bank competition fosters the willingness of banks to lend.

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    Bibliographic Info

    Paper provided by International Monetary Fund in its series IMF Working Papers with number 06/297.

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    Length: 49
    Date of creation: 01 Dec 2006
    Date of revision:
    Handle: RePEc:imf:imfwpa:06/297

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    Related research

    Keywords: Bank soundness; Profits; Asset management; Resource allocation; Risk management; Economic models; banking; predictions; instrumental variables; probability; bank profits; return on assets; equation; bank size; logarithm; dummy variables; statistics; bank assets; bank competition; standard deviation; samples; interest expense; correlations; correlation; bank risk; prediction; bank markets; deposit insurance; independent variables; bank asset; time series; bank failure; bank deposits; banking markets; bank market; banking systems; risk of bank failure; bank risk taking; bank profitability; banking facilities; banking services; bank risk-taking; bank holding companies; banks ? asset; bank equity; bank failures; econometrics; bank profit; prudential regulation; statistic; proxy measure; standard deviations; computations; bank debt; bank branch; deposit insurance premium; bank regulation; computation; banking industry; banking market; bank activities; confidence intervals; income statement; bank problem; bank commitment; outliers; bank capitalization; banking models; bank consolidation; insurance premium; banking stability; significance levels; bank services; bank stability; financial risk; equations; bank loan; bank holding; bank asset allocation; instrumental variable;

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    References

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    1. Allen, Franklin & Gale, Douglas, 2004. "Competition and Financial Stability," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(3), pages 453-80, June.
    2. Rafael Repullo, 2002. "Capital requirements, market power, and risk-taking in banking," Proceedings 809, Federal Reserve Bank of Chicago.
    3. John H. Boyd & Gianni De Nicolã, 2005. "The Theory of Bank Risk Taking and Competition Revisited," Journal of Finance, American Finance Association, vol. 60(3), pages 1329-1343, 06.
    4. Bresnahan, Timothy F., 1989. "Empirical studies of industries with market power," Handbook of Industrial Organization, in: R. Schmalensee & R. Willig (ed.), Handbook of Industrial Organization, edition 1, volume 2, chapter 17, pages 1011-1057 Elsevier.
    5. Claessens, Stijn & Laeven, Luc, 2004. "What Drives Bank Competition? Some International Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(3), pages 563-83, June.
    6. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
    7. Hannan, Timothy H, 1991. "Foundations of the Structure-Conduct-Performance Paradigm in Banking," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(1), pages 68-84, February.
    8. Jeffrey M. Wooldridge, 2003. "Cluster-Sample Methods in Applied Econometrics," American Economic Review, American Economic Association, vol. 93(2), pages 133-138, May.
    9. John H. Boyd & Edward C. Prescott, 1985. "Financial intermediary-coalitions," Staff Report 87, Federal Reserve Bank of Minneapolis.
    10. Gianni De Nicolo, 2000. "Size, charter value and risk in banking: an international perspective," International Finance Discussion Papers 689, Board of Governors of the Federal Reserve System (U.S.).
    11. David M. Kreps & Jose A. Scheinkman, 1983. "Quantity Precommitment and Bertrand Competition Yield Cournot Outcomes," Bell Journal of Economics, The RAND Corporation, vol. 14(2), pages 326-337, Autumn.
    12. Stephen D. Williamson, 1984. "Costly Monitoring, Financial Intermediation, and Equilibrium Credit Rationing," Working Papers 583, Queen's University, Department of Economics.
    13. Keeley, Michael C, 1990. "Deposit Insurance, Risk, and Market Power in Banking," American Economic Review, American Economic Association, vol. 80(5), pages 1183-1200, December.
    14. Shaffer, Sherrill, 2004. "Comment on "What Drives Bank Competition? Some International Evidence" by Stijn Claessens and Luc Laeven," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 36(3), pages 585-92, June.
    15. Demsetz, Rebecca S & Strahan, Philip E, 1997. "Diversification, Size, and Risk at Bank Holding Companies," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(3), pages 300-313, August.
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