Bank Competition and Financial Stability: Evidence from the Financial Crisis

Abstract

We examine the link between bank competition and financial stability using the recent financial crisis as the setting. We utilize variation in banking competition at the state level and find that banks facing less competition are more likely to engage in risky activities, more likely to face regulatory intervention, and more likely to fail. Focusing on the real estate market, we find that states with less competition had higher rates of mortgage approval, experienced greater inflation in housing prices before the crisis, and experienced a steeper decline in housing prices during the crisis. Overall, our study is consistent with greater competition increasing financial stability.

Bank-Specific Shocks and House Price Growth in the U.S.

“…In accordance with column (4) of Table 3, the marginal effect of BGR on house price growth is becoming stronger with increasing mortgage market concentration. Hence, our results seem to point in the same direction as recent findings by Akins et al (2016) who show that U.S. states that have less competitive banking markets experienced -among others -a much higher growth in house prices before the crisis of 2007-09.…”

Research in finance: A review of influential publications and a research agenda

“…Another prominent research stream is access to capital and changes in investment during financial crises (Campello et al, 2011;Kahle and Stulz, 2013). Other interesting emerging topics are the effect of regulatory risk on markets (Pastor and Veronesi, 2013), the prospects of strategic default by borrowers (Favara et al, 2012), the transmission of bank distress to nonfinancial firms (Carvalho et al, 2015), the link between bank competition and financial stability (Akins et al, 2014), cross-market transmission of risk (Bekaert et al, 2014) and formative experience and portfolio choice around the Finnish great depression (Knüpfer et al, 2017).…”

Competition, bank fragility, and financial crisis

“…On the one hand, more competition shrinks a bank's ability to reap profit and results in lower charter value, which induces the bank to compensate it by taking higher risk (e.g., Keeley, 1990;Hellmann et al, 2000;Repullo, 2004). On the other hand, more competition makes bank loans cheaper, which lessens moral hazard incentives of borrowers to shift into riskier projects and draws a safer set of borrowers (e.g., Boyd Akins et al, 2016). Moreover, more competition might promote a less concentrated banking system with fewer too-big-to-fail (TBTF) banks that benefit most from the government's implicit or explicit bailout program (Berger et al, 2009).…”