Legal Investigate

Bank Competition And Financial Stability

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Executive Summary

Under the traditional "Competition-fragility" view, more bank competition erodes market power, decreases profit margins, and results in reduced franchise value that encourages bank risk taking. Under the alternative "Competition-stability" view, more market power in the loan market may result in greater bank risk as the higher interest rates charged to loan customers make it more difficult to repay loans and exacerbate moral hazard and adverse selection problems. But even if market power in the loan market results in riskier loan portfolios, the overall risks of banks need not increase if banks protect their franchise values by increasing their equity capital or engaging in other risk-mitigating techniques.

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