Bank Equity Capital and Risk-taking Behavior: The Eff ect of Competition

We examine how the relationship between bank equity capital and risk taking changes in the presence of other risk-mitigating devices such as increased competition in the banking market. We show that competition is not only an alternative mechanism to mitigate risk-taking, but also dampens the relationship between bank capital ratios and risk-taking. More speci cally, when facing increased competition, low-capital banks engage in relatively larger reductions in risk-taking. They do so primarily by decreasing the risk in their lending portfolios. This empirical nding suggests that the competitive landscape in the banking sector should be taken into account when considering changes in capital requirement to improve fi nancial stability.