Quality of Bank Capital, Competition, and Risk-Taking

Abstract

AbstractThis chapter empirically investigates how bank capital and competitive conditions affect bank risk-taking. Using financial data of 7620 banks on 118 countries from 2001 to 2016, we show that banks with a higher Tier 1 ratio and a lower Tier 2 ratio are lower risk-takers. A bank with greater market power in a banking system tends to reduce its risk-taking activities. Our findings also highlight that the negative relationship between Tier 1 ratio and bank risk are more pronounced in more competitive conditions. During the financial crisis, Tier 1 capital acted as a stable funding source and reduced bank risk, but the evidence on Tier 2 capital shows that a higher Tier 2 ratio results in a higher level of risk and increases bank instability.