Bank Competition and Stability: Reconciling Conflicting Empirical Evidence

Posted by D. Daniel Sokol

Thorsten Beck, Professor, CentER, European Banking Center, Tilburg University, Olivier De Jonghe, Tilburg University - Department of Finance, Tilburg University - European Banking Center, and Glenn Schepens, Ghent University - Department of Financial Economics address Bank Competition and Stability: Reconciling Conflicting Empirical Evidence.

ABSTRACT: Theoretical models and empirical results offer conflicting evidence on the relationship between bank competition and bank stability. This paper aims to reconcile the seemingly contrasting evidence on the bank competition-bank soundness relationship. We develop a unified framework to assess how regulation, supervision and other institutional factors may make it more likely that the data favor one theory over the other (charter value paradigm versus risk-shifting paradigm). Cross-country heterogeneity in these factors allows us to test the assumptions and predictions of various theoretical models. We show that an increase in competition will have a larger impact on banks' risk taking incentives in countries with stricter activity restrictions, more herding in revenue structure and unconcentrated banking markets.