Competition and risk‐taking in investment banking

Abstract

How does competition affect the investment banking business and the risks individual institutions are exposed to? Using a large sample of investment banks operating in seven developed economies over 1997–2014, we apply a panel VAR model to examine the relationships between competition and risk without assuming any a priori restrictions. Our main finding is that investment banks’ higher risk exposure, measured as a long‐term capital‐at‐risk and return volatility, was facilitated by greater competitive pressures for both boutique investment banks and full‐service investment banks. Overall, we find some evidence that more competition leads to more fragility before and during the recent financial crisis.

Competition and stability in the credit industry: Banking vs. factoring industries

“…Firm stability is estimated using two variables: the Z-score and the Capital at Risk (CAR). Competition is estimated using the Lerner Index which is employed extensively in the existing banking literature (Carbò et al, 2009;Cipollini and Fiordelisi, 2012;Fiordelisi and Mare, 2014, Degl'Innocenti et al, 2018, 2019Clark et al, 2018, Fiordelisi, Mare, andMolyneux 2018). We use a panel-data vector auto-regression to examine the link between competition and bank risk measures.…”

“…Particularly, we use the Lerner index of monopoly power (LER), that has been largely adopted in past studies analysing competition in banking (recently, Turk-Ariss, 2010; Mare, 2014 Forssbaeck andShehzad, 2014;Degl'Innocenti et al, 2018, 2019Clark et al, 2018).…”

“…Competition is seen to play a pivotal role in spurring greater efficiency, innovation, and generally in favouring a more efficient allocation of financial resources. However, the recent financial crisis has raised some concerns among scholars and policy makers on its role in stimulating higher bank risk-taking (Degl'Innocenti et al, 2019).…”

“…Consequently, we define the input prices as follows: human capital price ( 1it W ) is obtained as the total personnel expenses and total assets; physical capital price ( 2it W ) is calculated as the ratio of other operating expenses and other administrative expenses to total fixed assets; and financial capital price ( 3it W ) is calculated as the total interest expenses over total liabilities. Regarding the second issue, we define a translog cost function (consistently with past papers, as Lu andWilson, Fiordelisi and Mare, 2014;Forssbaeck and Shehzad, 2015;Clark et al, 2018;Degl'Innocenti et al, 2019) 10 , for each industry as follows:…”

Bank competition and the design of syndicated loans

“…Jiang et al (2020) andDegl'Innocenti et al (2019) review the literature on the relationship between bank competition and risk taking. According toDegl'Innocenti et al (2019), there is a strong empirical relationship between bank competition and risk, and that increased bank competition is associated with increased lending to riskier firms.…”