Banking Competition and Stability

The Role of Leverage

X. Freixas, K. Ma

Research output: Working paperDiscussion paperOther research output

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Abstract

This paper reexamines the classical issue of the possible trade-offs between banking competition and financial stability by highlighting different types of risk and the role of leverage. By means of a simple model we show that competition can affect portfolio risk, insolvency risk, liquidity risk, and systemic risk differently. The effect depends crucially on banks’ liability structure, on whether banks are financed by insured retail deposits or by uninsured wholesale debts, and on whether the indebtness is exogenous or endogenous. In particular we suggest that, while in a classical originate-to-hold banking industry competition
might increase financial stability, the opposite can be true for an originate-to-distribute banking industry of a larger fraction of market short-term funding. This leads us to revisit the existing empirical literature using a more precise classification of risk. Our theoretical model therefore helps to clarify a number of apparently contradictory empirical results and proposes new ways to analyze the impact of banking competition on financial stability
Original languageEnglish
Place of PublicationTilburg
PublisherEBC
Number of pages41
Volume2014-009
Publication statusPublished - 29 Aug 2014

Publication series

NameEBC Discussion Paper
Volume2014-009

Fingerprint

Financial stability
Leverage
Banking competition
Banking industry
Liability
Portfolio risk
Retail
Liquidity risk
Empirical results
Deposits
Insolvency risk
Trade-offs
Debt
Systemic risk
Funding

Keywords

  • banking competition
  • financial stability
  • leverage

Cite this

Freixas, X., & Ma, K. (2014). Banking Competition and Stability: The Role of Leverage. (EBC Discussion Paper; Vol. 2014-009). Tilburg: EBC.
Freixas, X. ; Ma, K. / Banking Competition and Stability : The Role of Leverage. Tilburg : EBC, 2014. (EBC Discussion Paper).
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Freixas, X & Ma, K 2014 'Banking Competition and Stability: The Role of Leverage' EBC Discussion Paper, vol. 2014-009, EBC, Tilburg.

Banking Competition and Stability : The Role of Leverage. / Freixas, X.; Ma, K.

Tilburg : EBC, 2014. (EBC Discussion Paper; Vol. 2014-009).

Research output: Working paperDiscussion paperOther research output

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AB - This paper reexamines the classical issue of the possible trade-offs between banking competition and financial stability by highlighting different types of risk and the role of leverage. By means of a simple model we show that competition can affect portfolio risk, insolvency risk, liquidity risk, and systemic risk differently. The effect depends crucially on banks’ liability structure, on whether banks are financed by insured retail deposits or by uninsured wholesale debts, and on whether the indebtness is exogenous or endogenous. In particular we suggest that, while in a classical originate-to-hold banking industry competitionmight increase financial stability, the opposite can be true for an originate-to-distribute banking industry of a larger fraction of market short-term funding. This leads us to revisit the existing empirical literature using a more precise classification of risk. Our theoretical model therefore helps to clarify a number of apparently contradictory empirical results and proposes new ways to analyze the impact of banking competition on financial stability

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Freixas X, Ma K. Banking Competition and Stability: The Role of Leverage. Tilburg: EBC. 2014 Aug 29. (EBC Discussion Paper).