Research findings: Banking sector risk, competition and capital - Prof Philip Davis and Ms Dilruba Karim

This work, led by Professor Philip Davis (Brunel University London) and Ms Dilruba Karim (Brunel University London) furnishes evidence on a number of unresolved issues in financial stability analysis:

• Both at a country level and a bank level, there is a tendency for both the leverage ratio and the risk-adjusted capital ratio to be significant predictors of risk.
• The leverage ratio is as often relevant as the risk-adjusted capital ratio, underlining its importance as a regulatory tool.
• Especially in our work on national data, the results for the relation of competition to risk strongly underpins the "competition-fragility" hypothesis that more competition entails greater risk-taking by banks, and show a widespread impact of competition on risk generally. 
• There are some differences between advanced countries and emerging market economies in the capital-risk-competition nexus, with for example a wider impact of competition in emerging market economies (although we suggest that both types of country need to pay careful attention to the evolution of competition in macroprudential surveillance).
• A shock to competition reduces leverage ratios and regulatory capital ratios significantly, giving a further reason for vigilance when competition increases. This result is consistent over a range of subsamples and risk variables.
• There is some evidence of greater vulnerability of weaker banks to low capital and high competition relative to the sample average or median.

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