Regulations, Competition and Bank Risk-Taking in Transition Countries

This study investigates the relationship between regulations, competition, and risk-taking in the Central and Eastern European banking sectors between 1994 and 2005. We build an empirical model that employs a non-structural measure of competition, various proxies for regulations and both static and dynamic empirical frameworks. We find no clear-cut positive relationship between conventional measures of banking sector regulatory reform and competition. In contrast, the more specific regulatory features that relate to restrictions on bank activities, capital requirements and official supervisory power play an important role in shaping competition. We also find that market power is negatively associated with the risk-taking behaviour of banks, while capital requirements and supervisory power seem to be effective devices in monitoring risk-taking as they increase equity to capital ratios and decrease credit risk. Finally, incentives and tools that enhance market self-monitoring also promote credit-risk reduction