Bank competition and credit risk: the conditioning role of capital

Christoffer Kok, Javier Arranz Barquero and Christian Hellum Bertelsen

No 3285, Working Paper Series from European Central Bank

Abstract: This paper examines how bank capital conditions the effect of competition on credit risk in lending markets, informing the debate on banking competition, deregulation, and risk-based supervision. Using ECB supervisory data for 146 euro area banks across 19 countries over 2020Q2–2025Q3, we analyze whether this relationship depends on banks’ regulatory capital positions. We find that greater market power is associated with higher subsequent credit risk, while stronger capitalization is associated with lower risk. Crucially, competition reduces credit risk primarily for well-capitalized banks, whereas the effect is weak or absent for banks with lower capital ratios. By aligning the measurement of competition and risk with the pricing-based mechanism, the paper provides a direct empirical test of the borrower-risk channel and offers an explanation for mixed evidence in the competition–risk literature. The results highlight the importance of considering the interaction between competition and prudential capital requirements when assessing financial stability. JEL Classification: G21, G28, L11, C23

Keywords: bank capital; bank competition; borrower-risk channel; credit risk; financial stability (search for similar items in EconPapers)
Date: 2026-09
New Economics Papers: this item is included in nep-com
Note: 508948
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20263285

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