Does Competition Affect Bank Risk?

Although policymakers often discuss trade-offs between bank competition and stability, past research provides differing theoretical perspectives and empirical results on the impact of competition on risk. We employ a new approach for identifying exogenous changes in the competitive pressures facing individual banks and discover that an intensification of competition materially boosts bank risk. With respect to the mechanisms, we find that competition reduces banks’ profits, pricing power, and charter values and increases banks’ provision of nontraditional, riskier banking services and lending to riskier firms.