Bank competition and financial stability

Allen N. Berger, Leora Klapper, Rima Turk-Ariss, Allen N. Berger, Leora F. Klapper and Rima Turk-Ariss
Authors registered in the RePEc Author Service: Leora F. Klapper and Rima Turk Ariss

No 4696, Policy Research Working Paper Series from The World Bank

Abstract: Under the traditional"competition-fragility"view, more bank competition erodes market power, decreases profit margins, and results in reduced franchise value that encourages bank risk taking. Under the alternative"competition-stability"view, more market power in the loan market may result in greater bank risk as the higher interest rates charged to loan customers make it more difficult to repay loans and exacerbate moral hazard and adverse selection problems. But even if market power in the loan market results in riskier loan portfolios, the overall risks of banks need not increase if banks protect their franchise values by increasing their equity capital or engaging in other risk-mitigating techniques. The authors test these theories by regressing measures of loan risk, bank risk, and bank equity capital on several measures of market power, as well as indicators of the business environment, using data for 8,235 banks in 23 developed nations. The results suggest that - consistent with the traditional"competition-fragility"view - banks with a greater degree of market power also have less overall risk exposure. The data also provide some support for one element of the"competition-stability"view - that market power increases loan portfolio risk. The authors show that this risk may be offset in part by higher equity capital ratios.

Keywords: Economic Growth; Business Environment; International Trade and Trade Rules; Banks&Banking Reform; Economic Conditions and Volatility (search for similar items in EconPapers)
Date: 2008-08-01
New Economics Papers: this item is included in nep-ban, nep-bec, nep-com, nep-fmk and nep-reg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (14)

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Related works:
Chapter: Bank competition and financial stability (2017)
Journal Article: Bank Competition and Financial Stability (2009)
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