How competition affects firm performance is a central question of economics. As in other sectors, competitive pressure in the banking sector can influence the efficiency of bank operations, the quality of financial products, and the extent of innovation. However, unique to the financial sector is the potential link between competition and financial stability. Does bank competition promote financial stability or undermine it by creating incentives for excessive risk-taking? Further, assessing the influence of bank competition on risk-taking behavior is of critical importance to financial analysts, credit rating agencies and investors who seek to forecast banks’ future prospects. This task is perhaps more difficult in banking relative to other industries, given the wide-spread perception that banks are unusually opaque.
In our paper, Perceived Bank Competition: Operational Decision-Making and Bank Stability, which was recently made publicly available on SSRN, we utilize a bank-specific measure that extracts a bank’s perception of its competitive environment from a textual analysis of its 10-K filing. The premise is that managers’ perceptions of the competitive environment influence their operating and risk-taking decisions. We show that this measure is related to future operating performance and bank decision-making in ways that suggest it captures real competitive forces exerting pressure on banks.