Bank Competition and Stability in the United Kingdom

Abstract

This paper examines the effects of competition on bank stability in the United Kingdom between 1994 and 2013. We construct several measures of competition and test the relationship between competition and bank stability. We find that, on average, competition lowers stability, but that its effect varies across banks depending on the underlying financial health of the institution. Competition encourages relatively less sound banks (closer to insolvency) to reduce costs, lower portfolio risk and increase capital ratios, strengthening their stability, while it lowers the incentives of relatively more sound banks (farther from insolvency) to build capital ratios, weakening their stability. These findings imply trade-offs at the bank-level that may need to be weighed when evaluating policies with consequences for competition.