PDF Ebook Market concentration and loan portfolios in commercial banking
The period between 1980 and 1994 saw large changes in the degree of competition in local banking markets. These changes stemmed in part from more permissive government policy toward mergers and geographic expansion in the banking sector, increases in the rate at which new banks were chartered, and rising rates of bank failure. Across local banking markets, concentration moved in different directions; some metropolitan areas saw increasing banking sector concentration, while in other markets concentration fell. The relevance of observed market concentration as a measure of competition may also have fall enduring this period, as almost all states enacted legislation that eased long-standing restrictions on the geographic expansion of banks and expanded the scope for potential competition to impact incumbent banks in local markets.
I use this recent historical record to estimate the relationship between market concentration and the risk profile of commercial bank lending. I find evidence that increasing competition, while reducing the overall share of assets that banks lend out, leads banks to shift lending toward the types of loans that have historically been most risky. This shift is associated with increasing overall portfolio risk and risk of bank failure. Because the federal government, through the Federal Deposit Insurance Corporation, stands ready to assume the assets and liabilities of failing banks, government policy that affects market concentration thus affects the value of the contingent liability from the government to the banking sector. Merton (1977), Kane (1985), and Boskin (1988) have pointed out that this contingent liability represents a very real and measurable cost borne by the federal government, though it is not explicitly accounted for in the official government budget.
This paper is designed to evaluate two potential mechanisms through which concentration may affect bank risk and lending activity. The first mechanism, prominent in the FDIC’s evaluation of the bank failures of the period, is that increasing competition erodes the value of existing banks and increases their willingness to invest in more speculative assets. However, if the return on safe assets is relatively unaffected by local market concentration, then competition may shift lending away from some risky loans. One mechanism for this effect, prominent in recent work by Petersen and Rajan (1995) is based on the implicit equity stake in “captive” borrowers that banks with market power enjoy. With risky new borrowers seeking loans, only banks with market power will have enough of an implicit equity stake in new borrowers to make risky loans profitable. The empirical evidence suggests that increasing concentration raises the total share of assets that banks lend out rather than invest in securities and other liquid assets, but shifts bank portfolios toward safer classes of loans, a result that is consistent with both types of models.
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PDF Ebook Market concentration and loan portfolios in commercial banking
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