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Competition has traditionally been considered a source of excessive
risk taking in banking and in consequence regulation has tried to
control it. Rate regulation, entry restrictions, and charter limitations
of banks (including the separation of commercial and investment banking)
have been used by regulators to limit competition. In Discussion Paper
No. 1177, Research Fellow Carmen Matutes and Programme Director
Xavier Vives study the links between competition for deposits and
risk taking in the banking sector. Their main purpose is to examine
whether `excessive' competition for deposits exists. To this end, they
explore how rate setting behaviour depends on the risk position of banks
both with and without deposit insurance, what are the derived incentives
for risk taking in the asset side, and how incentives change with rate
regulation. They develop a model of banking competition which allows
them to disentangle the roles that limited liability, deposit insurance
(both with flat and risk-based premia), and rivalry for deposits play in
determining risk-taking incentives both in the asset and the liability
side of the balance sheet |