Bank Competition and Financial Stability |
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Authors: | Allen N Berger Leora F Klapper Rima Turk-Ariss |
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Institution: | (1) Moore School of Business, University of South Carolina, 1705 College Street, Columbia, SC 29208, USA;(2) Wharton Financial Institutions Center, Philadelphia, PA, USA;(3) CentER—Tilburg University, Tilburg, The Netherlands;(4) The World Bank, Washington, DC, USA;(5) Lebanese American University, Beirut, Lebanon |
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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 higher bank risk as the higher interest rates charged to loan customers make
it harder to repay loans, and exacerbate moral hazard and adverse selection problems. The two strands of the literature need
not necessarily yield opposing predictions regarding the effects of competition and market power on stability in banking.
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. We
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. Our results
suggest that—consistent with the traditional “competition-fragility” view—banks with a higher degree of market power also
have less overall risk exposure. The data also provides some support for one element of the “competition-stability” view—that
market power increases loan portfolio risk. We show that this risk may be offset in part by higher equity capital ratios.
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Keywords: | Bank competition Banking system fragility Financial stability Regulation |
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