A new paper suggests that concentration in banking produces safer, more diversified banks.

The U.S. National Bureau of Economic Research (NBER) paper by co-authors Thorsten Beck, Asli Demirguc-Kunt, and Ross Levine studies the impact of bank concentration, bank regulations, and national institutions on the probability of experiencing a systemic banking crisis. They relied on data gathered from 70 countries over the period 1980-97.

The authors note that opposite views exist on the question of whether bank consolidation in various countries enhances financial stability. “Some analysts emphasize that large banks can diversify better, earn higher profits, take fewer risks, and can be monitored by regulatory agencies more easily, all of which bodes well for stability. However, other studies maintain that because large banks frequently receive subsidies under ‘too big to fail policies,’ these financial institutions in fact may take greater risks, and indeed their very size and complexity may make them more difficult to oversee.”

The authors find, “Fewer regulatory restrictions on banks – lower barriers to bank entry and fewer restrictions on banking activities – reduce bank vulnerability. Indeed, entry barriers and activity restrictions have a destabilizing effect on banking systems.”

NBER says that Beck, Demirguc-Kunt, and Levine produce three major findings. “First, they find that crises are less likely in more concentrated banking systems, even after controlling for a wide array of macroeconomic, regulatory, and institutional factors. Second, more competition lowers the probability that a country will suffer a systemic banking crisis. Third, countries whose national institutions promote competition in general have a lower likelihood of suffering a systemic banking crisis.”

“In terms of linking these findings to specific parts of the concentration-stability view, the finding that competition reduces fragility is inconsistent with the argument that concentrated banking systems boost profits and therefore reduce fragility. Rather, the evidence is more consistent with the view that concentrated banking systems tend to have banks that are better diversified or are easier to monitor than banks in less concentrated banking systems,” NBER concludes.