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Credit market competition and liquidity crises

Carletti, Elena, Leonello, Agnese, (2016), “Credit market competition and liquidity crises”, ECB, No 1932 / July 2016

So far the debate among policymakers and academics has focused on the effect that competition has on the credit risk banks are exposed to. In the academic literature, two opposing views can be distinguished depending on how competition affects banks’ and borrowers’ risk taking behavior. One view is that, by reducing banks’ franchise value, competition reduces banks’ incentives to behave prudently (e.g., Keeley, 1990, Hellman, Murdoch and Stiglitz, 2000, and Allen and Gale, 2004a). An opposite view is that the low loan rates associated with intense competition induce borrowers to take less risk, thus reducing banks’ portfolio risk (e.g., Boyd and De Nicolo, 2005).

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