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Competition Stability Model

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The core business of the retail banking industry and the banking industry as a whole involves taking risks mainly when offering credit facilities to borrowers. It is for this reason that the risk taking behavior of a bank will always have an impact on the bank’s profitability and ultimately on whether or not the bank remains a going concern. This is despite that in a number of countries the non-interest income on banks is growing in importance; after-all loans constitute the largest share of bank’s assets.
Over the years there has been a significant amount of research on the effects of competition on the risk taking behavior of banks and hence their stability. This has been coupled with inquiries by different competition authorities around …show more content…

They dub the first view as the competition-fragility view and the second view as the competition-stability view. On one hand, the competition-fragility view which is similar to what is known as the franchise value paradigm points out to a negative relationship between competition and financial stability which can be explained to mean that with increased competition banks become reckless, taking more risks to increase profits and as a result becoming unstable. The competition-stability view on the other hand points to a positive relationship between competition and stability which implies a positive relationship between competition and the risk taking behavior of …show more content…

Theory suggests that there are two hypotheses that explain the relationship between competition and the risk taking behavior of banks, namely: the competition-fragility view, also known as the Franchise value paradigm; and the competition stability view. It is also assumed that the more risk that the banks take the more profitable it will be, however that is as long as the risks do not materialize. One study by Tan and Anchor (2016) confirms this relationship between risk taking and profitability as it finds that higher profitability leads to higher bank fragility. With this relationship always assumed to hold most researches tend to focus on the relationship between competition and the risk taking behavior of

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