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Does Competition Reduce the Risk of Bank Failure?

Author

Listed:
  • David Martinez-Miera
  • Rafael Repullo

Abstract

A large theoretical literature shows that competition reduces banks' franchise values and induces them to take more risk. Recent research contradicts this result: When banks charge lower rates, their borrowers have an incentive to choose safer investments, so they will in turn be safer. However, this argument does not take into account the fact that lower rates also reduce the banks' revenues from performing loans. This paper shows that when this effect is taken into account, a U-shaped relationship between competition and the risk of bank failure generally obtains. The Author 2010. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.

Suggested Citation

  • David Martinez-Miera & Rafael Repullo, 2010. "Does Competition Reduce the Risk of Bank Failure?," The Review of Financial Studies, Society for Financial Studies, vol. 23(10), pages 3638-3664, October.
    • Handle: RePEc:oup:rfinst:v:23:y:2010:i:10:p:3638-3664
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    File URL: http://hdl.handle.net/10.1093/rfs/hhq057
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    JEL classification:

    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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