NCPA - National Center for Policy Analysis

Bigger Banks Can Reduce Risk

April 2, 2004

Many analysts believe that large, highly concentrated banks diversify better, earn higher profits, take fewer risks and can be monitored by regulatory agencies more easily. Others argue that these banks become "too big to fail" and are inefficiently subsidized by government agencies.

A new paper from the National Bureau of Economic Research finds that more highly concentrated banking systems are less likely to suffer major crises, even after controlling for a wide array of macroeconomic, regulatory and institutional factors. Even more importantly, the paper argues that healthy competition is extremely important for stability. The authors argue that:

  • Regulatory restrictions such as entry barriers and activity restrictions have destabilizing effect on banking systems.
  • Evidence shows that banking systems where a larger fraction of entry applications are denied, and those where regulations restrict banks from engaging in non-lending activities, have a greater chance of experiencing a system crisis.
  • Additionally, nations that promote competition in general have a lower likelihood of suffering a systematic banking crisis.

The authors conclude that concentrated banking systems tend to have banks that are better diversified and are easier to monitor than banking in less concentrated banking systems.

Source: Matt Nesvisky, "Bank Concentration and Crises," NBER Digest, February 2004; based upon: Thorsten Beck, Asli Demirguc-Kunt, and Ross Levine, "Bank Concentration and Crises," National Bureau of Economic Research, Working Paper No. 9921, August 2003.

For NBER text

For study abstract


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