Bank competition reduces credit risk only in well-capitalized banks
Increased lending competition lowers corporate credit risk primarily for well-capitalized banks, according to an ECB working paper analyzing 146 euro area lenders from 2020 to 2025. For institutions with low capital or thin supervisory headroom, the stabilizing effect disappears.
The borrower-risk transmission
Authors Javier Arranz Barquero, Christian Hellum Bertelsen, and Christoffer Kok analyze confidential supervisory data for 146 lenders across 19 countries between 2020Q2 and 2025Q3. They evaluate corporate lending using a risk-adjusted Lerner index on new credit alongside non-performing loan, Stage 3, and default ratios.
Across specifications, greater market power is associated with higher subsequent credit risk.
Crucially, at the 90th percentile of Tier 1 capitalization, a one-standard-deviation rise in competition reduces NPL and Stage 3 ratios by 77bp and default ratios by 87bp.
For poorly capitalized lenders, the risk-reducing effect of competitive pressure is weak or absent.
Buffers beyond minimum thresholds
The findings hold across regulatory capital ratios—CET1, Tier 1, and total capital—as well as supervisory headroom above the Overall Capital Requirement and Pillar 2 Guidance.
The authors show that empirical inconsistencies in previous academic literature stem from misaligned metrics, such as using bank-wide profitability rather than loan pricing.
Utilizing dynamic difference-GMM panel estimation, the study demonstrates that distance from binding prudential constraints dictates whether competition improves asset quality.
Prudence precedes competition
The analysis cleanly resolves an academic dispute by linking loan pricing directly to default metrics.
Regulators must recognize that competitive forces only deliver stability when lenders hold substantial balance-sheet cushions.
Prudential policy and market deregulation cannot be treated as independent levers.