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Is there a competition-stability trade-off in European banking?

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  • Leroy, Aurélien
  • Lucotte, Yannick

Abstract

The existence of a trade-off between bank competition and financial stability has always been a controversial issue, both among policy makers and academics. This paper empirically re-investigates the relationship between competition and bank risk across a large sample of European listed banks over the period 2004–2013. However, in contrast to most extant literature, we consider both individual and systemic dimensions of risk. Bank-individual risk is measured by the Z-score and the distance-to-default, while we consider the SRISK as a proxy for bank systemic risk. Using the Lerner index as an inverse measure of competition and after controlling for a variety of bank-specific and macroeconomic factors, our results suggest that competition encourages bank risk-taking and then increases individual bank fragility. This result is in line with the traditional “competition-fragility” view. Our most important findings concern the relationship between competition and systemic risk. Indeed, contrary to our previous results, we find that competition enhances financial stability by decreasing systemic risk. This result can be explained by the fact that weak competition tends to increase the correlation in the risk-taking behavior of banks.

Suggested Citation

  • Leroy, Aurélien & Lucotte, Yannick, 2017. "Is there a competition-stability trade-off in European banking?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 46(C), pages 199-215.
  • Handle: RePEc:eee:intfin:v:46:y:2017:i:c:p:199-215
    DOI: 10.1016/j.intfin.2016.08.009
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    Cited by:

    1. Shijaku, Gerti, 2017. "Bank Stability and Competition: Evidence from Albanian Banking Market," MPRA Paper 79891, University Library of Munich, Germany.
    2. repec:bkr:journl:v:77:y:2018:i:2:p:22-50 is not listed on IDEAS
    3. Shijaku, Gerti, 2016. "Does bank competition affect bank stability after the global financial crisis?," MPRA Paper 79084, University Library of Munich, Germany.
    4. Sherrill Shaffer & Laura Spierdijk, 2019. "Measuring multi-product banks' market power using the Lerner index," CAMA Working Papers 2019-17, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    5. Samangi Bandaranayake & Kuntal K. Das & W. Robert Reed, 2019. "Another Look at “Bank Competition and Financial Stability: Much Ado about Nothing?”," Working Papers in Economics 19/08, University of Canterbury, Department of Economics and Finance.
    6. Samangi Bandaranayake & Kuntal K. Das & W. Robert Reed, 2018. "A Replication of “Bank Competition and Financial Stability: Much Ado About Nothing?” (Journal of Economic Surveys, 2016)," Working Papers in Economics 18/18, University of Canterbury, Department of Economics and Finance.
    7. repec:seb:journl:v:15:y:2017:i:2:p:175-208 is not listed on IDEAS
    8. repec:ris:ecoint:0824 is not listed on IDEAS
    9. Tatiana Gaelle Yongoua Tchikanda, 2017. "Systemic risk and individual risk: A trade-off?," EconomiX Working Papers 2017-16, University of Paris Nanterre, EconomiX.
    10. Wataru Hirata & Mayumi Ojima, 2019. "Competition and Bank Systemic Risk: New Evidence from Japan's Regional Banking," Bank of Japan Working Paper Series 19-E-1, Bank of Japan.
    11. repec:eee:ememar:v:38:y:2019:i:c:p:310-325 is not listed on IDEAS

    More about this item

    Keywords

    Bank competition; Lerner index; Financial stability; Bank-risk taking; Systemic risk; Competition policy;

    JEL classification:

    • 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
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation

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