Journal Article

Does Competition Reduce the Risk of Bank Failure?

David Martinez-Miera and Rafael Repullo

in The Review of Financial Studies

Published on behalf of The Society for Financial Studies

Volume 23, issue 10, pages 3638-3664
Published in print October 2010 | ISSN: 0893-9454
Published online August 2010 | e-ISSN: 1465-7368 | DOI: https://dx.doi.org/10.1093/rfs/hhq057

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A large theoretical literature shows that competition reduces banks' franchise values and induces them to take more risk. Recent research contradicts this result: When banks charge lower rates, their borrowers have an incentive to choose safer investments, so they will in turn be safer. However, this argument does not take into account the fact that lower rates also reduce the banks' revenues from performing loans. This paper shows that when this effect is taken into account, a U-shaped relationship between competition and the risk of bank failure generally obtains.

Keywords: G21; D43; E43

Journal Article.  11196 words.  Illustrated.

Subjects: Banking ; Market Structure and Pricing ; Money and Interest Rates