in banking). There exist theoretical arguments as well as empirical evidence that more
efficient banks are less risky. First, Petersen and Rajan (1995) argue that more efficient
banks have better screening and monitoring abilities. At the empirical front, Berger and
DeYoung (1997) show that more efficient banks have lower non-performing loans ratio.
Taken together with our finding that the Boone Indicator has a negative effect on bank
risk taking suggests that competition has a stability enhancing effect via an improvement
in bank efficiency, and more specifically by improving banks’ monitoring and screening
procedures (see Schaeck and Cihak 2010 for a similar argument). Viewed from a more
theoretical angle, the result that higher pricing power reduces bank risk taking supports
the idea that higher franchise values mitigate the risk-shifting incentives of banks, thus
contributing to a more stable banking system. Simultaneously, higher bank competition
reduces risk-shifting incentives at the borrower level by forcing banks to develop more
efficient screening and monitoring mechanisms.