Market Integration and Bank Risk-Taking

December 30, 2020
By Kaniska Dam and Rajdeep Sengupta


Research Working PaperIncreased bank competition from market integration affects banks’ risk-taking behavior in ways beyond a simple increase in the number of competitor banks.

Using a workhorse model of bank competition and risk-taking, we show that increased competition from market integration affects bank risk-taking in ways beyond a simple increase in the number of competitor banks. Research has shown that increased competition in the form of an increase in the number of competitor banks can reduce risk-taking—the bank-competitor effect. Market integration not only increases the number of banks, but also the number of potential customers (depositors and borrowers) available to each bank. Increases in the potential customer base induces banks to behave more like price-takers in both deposit and loan markets. We show that increased competition in the form of convergence toward banks’ price-taking behavior can either increase or decrease bank risk-taking—the bank customer effect. When these effects oppose each other, increased competition from market integration can potentially increase, rather than decrease, bank risk-taking. Even in the absence of the bank-customer effect, we show that market integration also affects risk-taking by facilitating bank mergers. By increasing concentration, bank mergers can potentially reverse the bank-competitor effect.

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RWP 20-21, December 2020

JEL Classification: D82, G21, L13

Article Citation

  • Dam, Kaniska, and Rajdeep Sengupta. 2020. “Market Integration and Bank Risk-Taking.” Federal Reserve Bank of Kansas City, Research Working Paper no. 20-21, December. Available at https://doi.org/10.18651/RWP2020-21