On the Relationship between Market Concentration and Bank Risk Taking

Kaniska Dam, Marc Escrihuela-Villar () and Santiago Sánchez-Pagés

No 36, DEA Working Papers from Universitat de les Illes Balears, Departament d'Economía Aplicada

Abstract: We analyse risk-taking behaviour of banks in the context of spatial competition. Banks mobilise unsecured deposits by offering deposit rates, which they invest either in a prudent or in a gambling asset. Limited liability along with high return of a successful gamble induce moral hazard at the bank level. We show that when the market concentration is low, banks invest in the gambling asset. On the other hand, for sufficiently high levels of market concentration, all banks choose the prudent asset to invest in. We further show that a merger of two neighboring banks increases the likelihood of prudent behaviour. Finally, introduction of a deposit insurance scheme exacerbates banks’ moral hazard problem.

Keywords: Market concentration; Bank mergers; Risk-taking (search for similar items in EconPapers)
JEL-codes: G21 L11 L13 (search for similar items in EconPapers)
Date: 2009
New Economics Papers: this item is included in nep-ban, nep-bec, nep-com and nep-cta
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Persistent link: https://EconPapers.repec.org/RePEc:ubi:deawps:36

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