Bank Risk-Taking and Competition Revisited

This paper studies two new models in which banks face a non-trivial asset allocation decision. The first model (CVH) predicts a negative relationship between banks'' risk of failure and concentration, indicating a trade-off between competition and stability. The second model (BDN) predicts a positive relationship, suggesting no such trade-off exists. Both models can predict a negative relationship between concentration and bank loan-to-asset ratios, and a nonmonotonic relationship between bank concentration and profitability. We explore these predictions empirically using a cross-sectional sample of about 2,500 U.S. banks in 2003 and a panel data set of about 2,600 banks in 134 nonindustrialized countries for 1993-2004. In both these samples, we find that banks'' probability of failure is positively and significantly related to concentration, loan-to-asset ratios are negatively and significantly related to concentration, and bank profits are positively and significantly related to concentration. Thus, the risk predictions of the CVH model are rejected, those of the BDN model are not, there is no trade-off between bank competition and stability, and bank competition fosters the willingness of banks to lend.Bank soundness;Profits;Asset management;Resource allocation;Risk management;Economic models;banking, predictions, instrumental variables, probability, bank profits, return on assets, equation, bank size, logarithm, dummy variables, statistics, bank assets, bank competition, standard deviation, samples, interest expense, correlations, correlation, bank risk, prediction, bank markets, deposit insurance, independent variables, bank asset, time series, bank failure, bank deposits, banking markets, bank market, banking systems, risk of bank failure, bank risk taking, bank profitability, banking facilities, banking services, bank risk-taking, bank holding companies, banks ? asset, bank equity, bank failures, econometrics, bank profit, prudential regulation, statistic, proxy measure, standard deviations, computations, bank debt, bank branch, deposit insurance premium, bank regulation, computation, banking industry, banking market, bank activities, confidence intervals, income statement, bank problem, bank commitment, outliers, bank capitalization, banking models, bank consolidation, insurance premium, banking stability, significance levels, bank services, bank stability, financial risk, equations, bank loan, bank holding, bank asset allocation, instrumental variable