A similar argument applies to the off-balance
sheet activities of banks: a high level of off-balance sheet activity might indicate higher
bank risk which is, however, unobservable when exclusively relying on balance sheet information.
In column three we add the variable Regional Geographic Reach. This
variable corresponds to a measure for a bank’s market power at the regional level. Given
that for the overwhelming majority of banks in Germany the relevant banking market is
the county the bank is located in (either by law or size of the bank) this variable can
therefore be interpreted as direct market-specific indicators of competition. The positive
and highly significant coefficient on the market share indicator supports the conclusion
that a higher market share of bank branches is positively related to bank instability in the
regional market. The risk increasing effect of a higher market share in the regional market
stands in contrast to the risk reducing effect of higher pricing power at the bank level
measured using bank-specific Lerner Indexes. One possible interpretation of this result is
that banks with a large branching network might be ”too-big-to-fail“ for this particular
regions. Moral hazard issues associated with the ”too-big-to-fail“ paradigm might lead
those banks to pursue riskier projects. Indeed, Dam and Koetter (2012) show that there
exists a strong moral hazard behavior among German banks which can be explained by
political economy considerations at the regional level. In column four we add the Boone
Indicator of competition.