Bank Risk-Taking and Competition Revisited

June 1, 2003

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Format: Chicago

Gianni De Nicolo, and John H. Boyd Bank Risk-Taking and Competition Revisited, (USA: International Monetary Fund, 2003) accessed November 8, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

This study reinvestigates the theoretical relationship between competition in banking and banks' exposure to risk of failure. There is a large existing literature that concludes that when banks are confronted with increased competition, they rationally choose more risky portfolios. We briefly review this literature and argue that it has had a significant influence on regulators and central bankers, causing them to take a less favorable view of competition and encouraging anti-competitive consolidation as a response to banking instability. We then show that existing theoretical analyses of this topic are fragile, since they do not detect two fundamental risk-incentive mechanisms that operate in exactly the opposite direction, causing banks to aquire more risk per portfolios as their markets become more concentrated. We argue that these mechanisms should be essential ingredients of models of bank competition.

Subject: Bank deposits, Banking, Competition, Deposit insurance, Financial crises, Financial institutions, Financial markets, Financial sector policy and analysis, Financial services, Loans, Moral hazard

Keywords: Bank deposits, Bank market, Bank risk choice, Bank risk shifting, Bankruptcy cost, Competition, Deposit insurance, Loan market risk channel, Loans, Moral hazard, Portfolio problem, WP

Publication Details

Pages:

24
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2003/114
Stock No:

WPIEA1142003
ISBN:

9781451853810
ISSN:

1018-5941

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