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Does Competition Reduce the Risk of Bank Failure?

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  • Martinez-Miera, David
  • Repullo, Rafael

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 non-defaulting 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.

Suggested Citation

  • Martinez-Miera, David & Repullo, Rafael, 2008. "Does Competition Reduce the Risk of Bank Failure?," CEPR Discussion Papers 6669, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:6669
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    More about this item

    Keywords

    Bank competition; Bank failure; Credit risk; Default correlation; Franchise values; Loan defaults; Loan rates; Moral hazard; Net interest income; Risk-shifting;
    All these keywords.

    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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