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Market Integration and Bank Risk-Taking

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  • Kaniska Dam
  • Rajdeep Sengupta

Abstract

Using a workhorse model of bank competition and risk-taking, we show that increased competition from market integration affects bank risk-taking in ways beyond a simple increase in the number of competitor banks. Research has shown that increased competition in the form of an increase in the number of competitor banks can reduce risk-taking—the bank-competitor effect. Market integration not only increases the number of banks, but also the number of potential customers (depositors and borrowers) available to each bank. Increases in the potential customer base induces banks to behave more like price-takers in both deposit and loan markets. We show that increased competition in the form of convergence toward banks’ price-taking behavior can either increase or decrease bank risk-taking—the bank customer effect. When these effects oppose each other, increased competition from market integration can potentially increase, rather than decrease, bank risk-taking. Even in the absence of the bank-customer effect, we show that market integration also affects risk-taking by facilitating bank mergers. By increasing concentration, bank mergers can potentially reverse the bank-competitor effect.

Suggested Citation

  • Kaniska Dam & Rajdeep Sengupta, 2020. "Market Integration and Bank Risk-Taking," Research Working Paper RWP 20-21, Federal Reserve Bank of Kansas City.
  • Handle: RePEc:fip:fedkrw:89533
    DOI: 10.18651/RWP2020-21
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    References listed on IDEAS

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    4. John H. Boyd & Gianni De Nicoló, 2005. "The Theory of Bank Risk Taking and Competition Revisited," Journal of Finance, American Finance Association, vol. 60(3), pages 1329-1343, June.
    5. Xavier Vives, 2016. "Competition and Stability in Banking: The Role of Regulation and Competition Policy," Economics Books, Princeton University Press, edition 1, number 10741.
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    More about this item

    Keywords

    Bank Competition; Market Integration;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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