Author(s):
Ziang Li, Jihong Song
Date:
February 2023
Abstract:
We document a novel fact about the cross-section of banks’ risk-taking behavior — banks with high deposit market power take on significantly less credit risk. In particular, the loan portfolios of high-market-power banks are much safer than those of low-market-power banks. This persistent relationship is not driven by the size, funding structure, loan market power, or geography of banks. Consequently, high-market-power banks earn higher profits, are less exposed to business cycle fluctuations, and sustain smaller losses in recessions. We propose a model where deposit market power increases banks’ franchise value and induces them to take on less risk to avoid defaults.