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Does Competition make Banks more Risk-seeking?

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  • Stefan Arping

    (University of Amsterdam)

Abstract

This article presents a model in which, contrary to conventional wisdom, competi- tion can make banks more reluctant to take excessive risks: As competition intensifies and margins decline, banks face more-binding threats of failure, to which they may respond by reducing their risk-taking. Yet, at the same time, banks become riskier. This is because the direct, destabilizing effect of lower margins outweighs the disciplining effect of competition; moreover, a substantial rise in competition reduces banks’ incentive to build precautionary capital buffers. A key implication is that the effects of competition on risk-taking and on failure risk can move in opposite directions.

Suggested Citation

  • Stefan Arping, 2014. "Does Competition make Banks more Risk-seeking?," Tinbergen Institute Discussion Papers 14-059/IV, Tinbergen Institute.
    • Handle: RePEc:tin:wpaper:20140059
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    File URL: https://papers.tinbergen.nl/14059.pdf
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    References listed on IDEAS

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    Cited by:

    1. Sanjukta Sarkar & Rudra Sensarma, 2016. "The relationship between competition and risk-taking behaviour of Indian banks," Journal of Financial Economic Policy, Emerald Group Publishing Limited, vol. 8(1), pages 95-119, April.

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    More about this item

    Keywords

    Charter Value Hypothesis; Bank Franchise Value; Bank Competition; Financial Stability; Capital Requirements;
    All these keywords.

    JEL classification:

    • G2 - Financial Economics - - Financial Institutions and Services
    • G3 - Financial Economics - - Corporate Finance and Governance

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