Competition and Stability in Banking

Abstract

In this paper, I review the state of the art of the academic, theoretical and empirical, literature on the potential trade-off between competition and stability in banking. There are two basic channels through which competition may increase instability: by exacerbating the coordination problem of depositors/investors on the liability side and fostering runs/panics; and by increasing incentives to take risk, and thus the probability of failure. The competition-stability trade-off is characterized and the implications of the analysis for regulation and competition policy discussed. Optimal regulation may depend on the intensity of competition.