Effect of the Equity Capital Ratio on the Relationship between Competition and Bank Risk-Taking Behavior

Abstract

Abstract We examine how the relationship between competition and risk-taking changes with the ex ante bank equity capital ratio. We show that competition in the banking market, on average, mitigates risk-taking by banks. This relationship, however, can be altered by a bank’s ex ante equity capital ratio. More specifically, when face with increased competition, banks with low ex ante equity capital ratios engage in relatively larger reductions in risk-taking. They do so primarily by decreasing the risk in their lending portfolios. In contrast, banks with high enough ex ante equity capital ratios might not reduce their risk-taking at all. (JEL G21, G32, O16, D40, G18)