Abstract
We consider the joint effect of competition and deposit insurance on risk taking by banks when bank risk is unobservable to depositors. It turns out that the magnitude of risk taking depends on the structure and side of the market in which competition takes place. If the bank is a monopoly or banks are competing only in the loan market, deposit insurance has no effect on risk taking. Banks in this situation tend to take risk, although extreme risk taking is avoided. In contrast, introducing deposit insurance increases risk taking if banks are competing for deposits. Then, deposit rates become excessively high, thereby forcing banks to take extreme risks.
Similar content being viewed by others
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
About this article
Cite this article
Niinimäki, JP. The Effects of Competition on Banks’ Risk Taking. JEcon 81, 199–222 (2004). https://doi.org/10.1007/s00712-003-0027-9
Received:
Revised:
Published:
Issue Date:
DOI: https://doi.org/10.1007/s00712-003-0027-9