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Deposit market competition, costs of funding and bank risk

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  • Ben R. Craig
  • Valeriya Dinger

Abstract

This paper presents an empirical examination of the effects of both deposit market competition and of wholesale funding on bank risk simultaneously. The traditional view of the relation between competition and risk has focused on the disciplining role of the charter value. In this project we argue that if the structure of bank liabilities and the costs of retail and wholesale funding are jointly determined with bank risk, the omission of wholesale funding in the empirical analysis of the relation between deposit market competition and risk may give rise to a substantial bias in the estimated results. This will be especially the case where wholesale lenders ?screen? their borrowers? risk as argued by the market discipline literature. We propose a new approach to the estimation of the relation between deposit market competition and bank risk which accounts for the opportunity of banks to shift to wholesale funding when deposit market competition is intense. The analysis is based on a unique comprehensive dataset which combines retail deposit rates data with data on bank characteristics and with data on local deposit market features for a sample of 589 US banks. Our results support the notion of a risk-enhancing effect of deposit market competition.

Suggested Citation

  • Ben R. Craig & Valeriya Dinger, 2009. "Deposit market competition, costs of funding and bank risk," Working Papers (Old Series) 0905, Federal Reserve Bank of Cleveland.
    • Handle: RePEc:fip:fedcwp:0905
    DOI: 10.26509/frbc-wp-200905
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    References listed on IDEAS

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    1. Stijn Claessens & Luc Laeven, 2004. "What drives bank competition? Some international evidence," Proceedings, Federal Reserve Bank of Cleveland, pages 563-592.
    2. Mr. Gianni De Nicolo & Abu M. Jalal & John H. Boyd, 2006. "Bank Risk-Taking and Competition Revisited: New Theory and New Evidence," IMF Working Papers 2006/297, International Monetary Fund.
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    Keywords

    Bank competition; Bank deposits;

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