We examine the link between bank competition and financial stability using the recent financial crisis as the setting. We utilize variation in banking competition at the state level and find that banks facing less competition are more likely to engage in risky activities, more likely to face regulatory intervention, and more likely to fail. Focusing on the real estate market, we find that states with less competition had higher rates of mortgage approval, experienced greater inflation in housing prices before the crisis, and experienced a steeper decline in housing prices during the crisis. Overall, our study is consistent with greater competition increasing financial stability.
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This paper has also benefited from comments we received from seminar participants at the Massachusetts Institute of Technology. We also wish to thank Rice University, Boston University, Singapore Management University, and London Business School for their financial support.
Copyright © Michael G. Foster School of Business, University of Washington 2016.