Bank competition and financial stability : evidence from the U.S. banking deregulation

This paper examines the causal relationship between banking competition and financial stability. We find that an exogenous competition shock significantly improved the stability of banks, consistent with the ‘competition-stability hypothesis’. We show that banks improved their cost efficiency and reduced credit risks in response to U.S. banking deregulation. In addition, we show the competition shock had a larger impact on banks who were initially operating in a less competitive environment. Our findings provide the first quasi-natural experimental evidence on the non-linear relationship between bank competition and financial stability.