Effect of the Equity Capital Ratio on the Relationship between Competition and Bank Risk-Taking Behavior

Liquidity and leverage

Jia Hao and Kuncheng Zheng

The Review of Corporate Finance Studies, 2021, vol. 10, issue 4, 813-855

Abstract: We examine how the relationship between competition and risk-taking changes with the ex ante bank equity capital ratio. We show that competition in the banking market, on average, mitigates risk-taking by banks. This relationship, however, can be altered by a bank’s ex ante equity capital ratio. More specifically, when face with increased competition, banks with low ex ante equity capital ratios engage in relatively larger reductions in risk-taking. They do so primarily by decreasing the risk in their lending portfolios. In contrast, banks with high enough ex ante equity capital ratios might not reduce their risk-taking at all. (JEL G21, G32, O16, D40, G18)

Date: 2021
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