HOW COMPETITION EFFECTS BANKS’ RISK TAKINGThe research examines how competition determines risk-taking behaviour amongst banks in the US banking industry. This is done by examining the relationship between proxies of bank risk taking such as loan loss provision (LLPTL), non-performance loans (LUFLT) and Z-score, and proxies of competition such as C5 concentration and Herfindahl-Hirschman index (HH

Abstract

The research examines how competition determines risk-taking behaviour amongst banks in the US banking industry. This is done by examining the relationship between proxies of bank risk taking such as loan loss provision (LLPTL), non-performance loans (LUFLT) and Z-score, and proxies of competition such as C5 concentration and Herfindahl-Hirschman index (HHI). The results of the research show that in the US banking industry Z-score and Herfindahl-Hirschman index (HHI) are positively correlated which is in accordance with competition fragility hypothesis. According to this hypothesis, competition amongst banks and risk-taking behaviour and positively related. The results of the research also show that Z-score and C5 concentration are negatively related. Since a lower concentration ratio indicates a higher competitive market and high concentration ratio indicates a less competitive market, the negative relationship between Z-score and C5 does not support the competition fragility hypothesis. The research also finds that LLPTL and HHI are negatively related and LLPTL and C5 concentration are positively related which is competition stability theory. The results also show that LUFTL and HHI are negatively correlated while LUFTL and C5 concentration are positively related which also supports competition stability theory. These means that Competition stability and competition fragility hypotheses are correct. The difference in the results only comes as a result of the uniqueness of characteristics of the industry being studied.