Banking Competition, Risk, and Regulation

By Wilko Bolt, A. Tieman. Social Science Research Network, 2004

141 citations recorded by the source corpus.

In a dynamic framework banks compete for customers by setting lending conditions for the loans they supply, taking into account the capital adequacy requirements posed by the regulator. By easing its lending conditions a bank faces a tradeoff between attracting more demand for loans, thus making higher per-period profits, and a deterioration of the quality of its loan portfolio, thus a higher risk of failure. Our main results state that more stringent capital adequacy requirements lead commercial banks to set more stringent loan conditions to their customers, and we show that increased competition in the banking industry leads banks to behave more risky. In this model we also look at risk-adjusted capital requirements and show that risk-based regulation is effective. We extend the basic model to have banks choose both their lending conditions and the level of bank capital. In this extended model it turns out that it may be beneficial for a bank to hold more equity than prescribed by the regulator, even though equity is more expensive than attracting deposits. We show that the same conclusions with respect to the effectiveness of regulation hold as in the standard model.

Subfields: Accounting, Economics and Econometrics, Finance

View Paper: https://www.semanticscholar.org/paper/e53c3bf3a2e39846d1b12a25941071455aa73e4e

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Citations in the corpus

Competitive Crowding and Risk Taking in a Tournament: Evidence from NASCAR Racing (2007, background): “Bolt and Tieman (2004) also found that greater rivalry in the banking industry led its incumbents into risky conduct.”
Exploring the Nexus between Banking Sector Reform and Performance: Evidence from Newly Acceded EU Countries (2008, background): “The first group of studies followed Keeley’s paradigm in examining the relationship between deregulation, bank risk-taking and competition, yielding however rather conflicting results (e.g. Matutes and Vives, 2000; Bolt and Tieman, 2004; Allen and Gale, 2004).”
Determinants of Non-Performing Loans: The Case of Eurozone (2014, background): “…competition increased banks’ credit risk, i.e. affecting their loan portfolios in terms of bad loan screening procedures and relaxing borrowing criteria (e.g. Michael Manove, Jorge A. Padilla, and Marco Pagano 2001; Wilko Bolt and Alexander F. Tieman 2004; Sangjun Jeong and Hueechae Jung 2013).”
Banking Competition and Capital Ratios (2007, unknown): “Moreover, this result is in line with the predictions in theoretical studies by Bolt and Tieman (2004) and Allen et al. (2005).”