Competition and Bank Risk-Taking - An Empirical Study

Abstract

The paper tests the effect of competition on bank risk-taking for a sample of up to 800 banks worldwide over the period 1995-2010. Following the theoretical literature on bank competition and risk more closely than previous empirical research, we measure competition at the bank level and separate the effects of competition in deposit and loan markets. We also condition the risk effect of competition on several factors, including proxies of charter value and deposit insurance coverage. Our results give clear evidence of a positive competition-risk effect for both risk measures tested. There is some indication, however, that this effect is strongly dependent on the existence of a deposit insurance-related moral hazard effect on risk, which is mitigated by increased market power. The frequently significant non-linearity of the competition-risk effect, and its dependence on safety-net characteristics could explain the conflicting results of previous empirical research.