Abstract
This paper examines the relationship between banking market structure and financial stability. Using data on thrifts, a type of banking institution specializing in residential mortgage lending, I test two related hypotheses. First, competition reduces franchise value. Second, reduced franchise value induces risk taking. Testing the second hypothesis exploits predictions that when hit by an exogenous shock, the slope of risk with respect to franchise value becomes more negative because thrifts adopt “bang-bang” strategies and choose minimal or maximal risk. Using the Texas real estate collapse in the 1980s as a natural experiment, I find evidence supporting both hypotheses.
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