Competition can boost macro-financial stability, research finds

A survey of 54 European banks shows increased competition increases the fragility of individual banks but decreases systemic risk, working paper says

Competition in the European banking sector increases risk-taking by individual banks but decreases the overall systemic risk, a working paper published this month by the Bank of Lithuania argues.

In Is there a competition-stability trade-off in European banking? Aurélien Leroy and Yannick Lucotte estimate the individual and systemic risk posed by 54 European banks between 2004 and 2013.

The authors use two proxies for individual risk for each bank, distance-to-default and the Z-score, while they use the recently-developed SRISK measure to estimate how much threat a single financial institution poses to the wider financial system. They use the Lerner index to measure banking competition.

The results might be explained, they suggest, by the fact weak competition increases the correlation in banks' risk-taking behaviour.


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