Risk-taking and bank competition under a low interest rate environment: Evidence from loan-level data

The literature has shown that loose monetary policy increases risky lending; however, it is unclear whether its effects are asymmetric based on the degree of bank competition. In this study, we attempt to fill this research gap by investigating how bank competition affects the transmission of monetary policy through a risk-taking channel. Using Japanese matched firm–bank loan data from fiscal years 1999 to 2019, we find that banks with weak market power engage in risky lending in a low interest rate environment. The effect of bank competition is stronger for lending to smaller risky firms than larger ones. We also find that low-capitalized banks and banks with high liquidity engage in risky lending after the introduction of the negative interest rate policy, supporting the view that banks lend their liquidity to risky firms for better yields because they cannot pass the negative interest rate on deposits. Validated by several robustness checks, our results suggest that a risk-taking channel operates differently, depending on the bank competition and other bank characteristics.