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Banking Competition and Stability : The Role of Leverage

Author

Listed:
  • Freixas, X.
  • Ma, K.

    (Tilburg University, Center For Economic Research)

Abstract

This paper reexamines the classical issue of the possible trade-offs between banking competition and financial stability by highlighting different types of risk and the role of leverage. By means of a simple model we show that competition can affect portfolio risk, insolvency risk, liquidity risk, and systemic risk differently. The effect depends crucially on banks’ liability structure, on whether banks are financed by insured retail deposits or by uninsured wholesale debts, and on whether the indebtness is exogenous or endogenous. In particular we suggest that, while in a classical originate-to-hold banking industry competition might increase financial stability, the opposite can be true for an originate-to-distribute banking industry of a larger fraction of market short-term funding. This leads us to revisit the existing empirical literature using a more precise classification of risk. Our theoretical model therefore helps to clarify a number of apparently contradictory empirical results and proposes new ways to analyze the impact of banking competition on financial stability.

Suggested Citation

  • Freixas, X. & Ma, K., 2014. "Banking Competition and Stability : The Role of Leverage," Discussion Paper 2014-048, Tilburg University, Center for Economic Research.
  • Handle: RePEc:tiu:tiucen:90204eef-6d8c-4bdc-86e7-b96e38f95e1f
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    References listed on IDEAS

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    Cited by:

    1. M. Brei & L. Jacolin & A. Noah, 2018. "Credit risk and bank competition in Sub-Saharan Africa," Working papers 664, Banque de France.
    2. Fiordelisi, Franco & Mare, Davide Salvatore & Molyneux, Philip, 2015. "State-Aid, Stability and Competition in European Banking," MPRA Paper 67473, University Library of Munich, Germany.
    3. Faia, Ester & Laffitte, Sebastien & Ottaviano, Gianmarco I.P., 2019. "Foreign expansion, competition and bank risk," Journal of International Economics, Elsevier, vol. 118(C), pages 179-199.
    4. CARLETTI, Elena & LEONELLO, Agnese, 2012. "Credit Market Competition and Liquidity Crises," Economics Working Papers ECO2012/14, European University Institute.
    5. Shamena Anwar & Patrick Bayer & Randi Hjalmarsson, 2019. "A Jury of Her Peers: The Impact of the First Female Jurors on Criminal Convictions," Economic Journal, Royal Economic Society, vol. 129(618), pages 603-650.
    6. E Philip Davis & Dilruba Karim & Dennison Noel, 2019. "The Bank Capital-Competition-Risk Nexus - A Global Perspective," National Institute of Economic and Social Research (NIESR) Discussion Papers 500, National Institute of Economic and Social Research.
    7. Elena Carletti & Agnese Leonello, 2014. "Credit Market Competition and Liquidity Crises," CESifo Working Paper Series 4647, CESifo Group Munich.
    8. Alfredo Martín Oliver & Sonia Ruano Pardo & Vicente Salas Fumás, 2014. "Productivity and welfare: an application to the Spanish banking industry," Working Papers 1426, Banco de España;Working Papers Homepage.

    More about this item

    Keywords

    Banking Competition; Financial Stability; Leverage;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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