Loan market competition and bank risk taking

W.B. Wagner

Research output: Contribution to journalArticleScientificpeer-review

Abstract

Recent literature (Boyd and De Nicoló, J Finance 60:1329–1343, 2005) has argued that competition in the loan market lowers bank risk by reducing the risk-taking incentives of borrowers. Using a model where competition arises from falling switching costs for entrepreneurs, we show that the impact of loan market competition on banks is reversed if banks can adjust their loan portfolios. The reason is that when borrowers become safer, banks want to offset the effect on their balance sheet and switch to higher-risk lending. They even overcompensate the effect of safer borrowers because loan market competition erodes their franchise values and thus increases their risk-taking incentives.
Original languageEnglish
Pages (from-to)71-81
JournalJournal of Financial Services Research
Volume37
Issue number1
Publication statusPublished - 2010

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Loans
Market competition
Bank risk taking
Incentives
Risk taking
Finance
Entrepreneurs
Switching costs
Franchise value
Balance sheet
Bank risk
Loan portfolio
Lending

Cite this

Wagner, W.B. / Loan market competition and bank risk taking. In: Journal of Financial Services Research. 2010 ; Vol. 37, No. 1. pp. 71-81.
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Loan market competition and bank risk taking. / Wagner, W.B.

In: Journal of Financial Services Research, Vol. 37, No. 1, 2010, p. 71-81.

Research output: Contribution to journalArticleScientificpeer-review

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AB - Recent literature (Boyd and De Nicoló, J Finance 60:1329–1343, 2005) has argued that competition in the loan market lowers bank risk by reducing the risk-taking incentives of borrowers. Using a model where competition arises from falling switching costs for entrepreneurs, we show that the impact of loan market competition on banks is reversed if banks can adjust their loan portfolios. The reason is that when borrowers become safer, banks want to offset the effect on their balance sheet and switch to higher-risk lending. They even overcompensate the effect of safer borrowers because loan market competition erodes their franchise values and thus increases their risk-taking incentives.

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