Abstract
AbstractThe current literature offers diverse findings on the bank competition‐risk relationship. We seek to advance understanding by looking at both short‐ and long‐run relationships for banks from 27 EU countries, using a six‐year period before and since 2007 and employing both the H‐statistic and the Lerner index as measures of competition. We thus highlight further nuances in the competition–risk relationship that are absent from the current literature. Both measures have a positive short‐run relationship with risk, while long‐run effects differ. Underlying this, the competition measures differ in their relationship to the volatility of profits, with important policy implications.
Highlights
IntroductionDAVIS AND KARIMThe subject of bank competition and risk has returned to the fore with the global financial crisis (GFC) in 2008–2009, with a popular view being that competition between financial institutions during the preceding boom was an important feature underlying the crisis (e.g., the majority view of the Financial Crisis Inquiry Commission, 2011)
The subject of bank competition and risk has returned to the fore with the global financial crisis (GFC) in 2008–2009, with a popular view being that competition between financial institutions during the preceding boom was an important feature underlying the crisis
This is, to our knowledge, the first empirical study of banking competition and risk to allow changes in competitive conditions, as well as levels, to impact on risk. It is one of the first studies to assess comparable periods before and after the GFC and to compare and contrast the results using two competition indicators: the H-statistic and the Lerner index
Summary
DAVIS AND KARIMThe subject of bank competition and risk has returned to the fore with the global financial crisis (GFC) in 2008–2009, with a popular view being that competition between financial institutions during the preceding boom was an important feature underlying the crisis (e.g., the majority view of the Financial Crisis Inquiry Commission, 2011). An extensive literature, generally estimated using pre-crisis data, finds diverse results for the relationship between competition and risk This follows, on the one hand, the socalled franchise value or competition–fragility approach − that more competition reduces the value of a banking licence and induces firms to take more risk − and, on the other hand, the competition–stability view, that, with low levels of competition, banks may charge excessively high rates of interest on loans and generate adverse selection and moral hazard on their loan books. Both types of results have been found in the empirical literature. An emerging set of studies suggests that both high and low levels of competition may be adverse for risk, that is, there is a U-shaped relationship, and that structural and regulatory features could affect country-level tradeoffs
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