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The Effects of Competition on Banks’ Risk Taking with and without Deposit Insurance

  • Niinimäki, Juha-Pekka


    (Bank of Finland Research)

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    We consider the joint effect of competition and deposit insurance on risk taking by banks when the riskiness of banks is unobservable to depositors. It turns out that the magnitude of risk taking depends on the type of bank competition. If the bank is a monopoly or banks compete only in the loan market, deposit insurance has no effect on risk taking. In that case the banks are too risky but extreme risk taking is avoided. In contrast, introducing deposit insurance increases risk taking if banks compete for deposits. Then, deposit rates become excessively high and force the banks to take extreme risks. Regarding the effects of increasing competition when there is deposit insurance, the results imply that deposit competition encourages risk taking but loan market competition does not. Our results can be extended more generally to insurance guaranty funds.

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    Paper provided by Bank of Finland in its series Research Discussion Papers with number 21/2000.

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    Length: 25 pages
    Date of creation: 18 Dec 2000
    Date of revision:
    Handle: RePEc:hhs:bofrdp:2000_021
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    Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland

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