Reflecting the opposing theoretical mechanisms, empirical studies find it diﬃcult to establish a clear relationship between competition and risk, and the link between risk and competition depends on the type of bank and the type of risk considered (Freixas and Ma 2014). Changing patterns of competition in the banking industry can have implications for financial stability that go beyond those for individual banks.
Insuﬃcient exit can lead to overcapacity and excessive risk-taking by weakly capitalized banks, weaken aggregate profitability, and limit banks’ ability to rebuild buffers following negative shocks. Generally, the link between competition and financial stability depends on the nature of the shock, risk-taking incentives at the level of the individual firm, and the overall structure of the banking system.