Handbook of Competition in Banking and Finance
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Handbook of Competition in Banking and Finance

Edited by Jacob A. Bikker and Laura Spierdijk

For academics, regulators and policymaker alike, it is crucial to measure financial sector competition by means of reliable, well-established methods. However, this is easier said than done. The goal of this Handbook is to provide a collection of state-of-the-art chapters to address this issue. The book consists of four parts, the first of which discusses the characteristics of various measures of financial sector competition. The second part includes several empirical studies on the level of, and trends in, competition across countries. The third part deals with the spillovers of market power to other sectors and the economy as a whole. Finally, the fourth part considers competition in banking submarkets and subsectors.
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Chapter 10: Bank competition and financial stability

Allen N. Berger, Leora F. Klapper and Rima Turk-Ariss

Abstract

Under the traditional “competition–fragility” view, more bank competition erodes market power, decreases profit margins, and results in reduced franchise value that encourages bank risk taking. Under the alternative “competition–stability” view, more market power in the loan market may result in higher bank risk, as the higher interest rates charged to loan customers make it harder to repay loans, and exacerbate moral hazard and adverse selection problems. The two strands of the literature need not necessarily yield opposing predictions regarding the effects of competition and market power on stability in banking. Even if market power in the loan market results in riskier loan portfolios, the overall risks of banks need not increase if banks protect their franchise values by increasing their equity capital or engaging in other risk-mitigating techniques. The authors test these theories by regressing measures of loan risk, bank risk, and bank equity capital on several measures of market power, as well as indicators of the business environment, using data for 8235 banks in 23 developed nations. The results suggest that – consistent with the traditional “competition–fragility” view – banks with a higher degree of market power also have less overall risk exposure. The data also provide some support for one element of the “competition–stability” view – that market power increases loan portfolio risk. The authors show that this risk may be offset in part by higher equity capital ratios.

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