Deposit Competition and Loan Markets

35 Pages Posted: 6 Aug 2013 Last revised: 17 Jun 2017

See all articles by Stefan Arping

Stefan Arping

University of Amsterdam Business School; Tinbergen Institute

Date Written: December 1, 2015

Abstract

Less-intense competition for deposits, by mitigating banks’ incentive to take excessive risks, is traditionally believed to lead to lower non-performing loan (NPL) ratios and more-stable banks. This paper revisits this proposition in a model with borrower moral hazard in which banks’ NPL ratios depend endogenously on their loan pricing. In relatively uncompetitive loan markets, less-fierce competition for deposits (i.e., lower deposit rates) leads to lower loan rates and, thus, safer loans. In more-competitive markets, the opposite can occur: As banks’ deposit-repayment burdens decline, they become less eager to risk-shift; this softens competition for risky loans, leading to higher loan rates and, ultimately, riskier loans. Overall, the model predicts a hump-shaped relationship between banks’ pricing power in deposit markets and their NPL ratios.

Keywords: Bank Competition, Loan Pricing, Financial Stability

JEL Classification: G2, G3

Suggested Citation

Arping, Stefan, Deposit Competition and Loan Markets (December 1, 2015). Journal of Banking and Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2306513 or http://dx.doi.org/10.2139/ssrn.2306513

Stefan Arping (Contact Author)

University of Amsterdam Business School ( email )

Roetersstraat 18
Amsterdam, 1018WB
Netherlands

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

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