The role of competition, innovation, and regulation on financial intermediary risk


This macroeconomic analysis chronicles the risk behavior of market-based financial intermediaries and traditional depository institutions from 1980 to 2010 and assesses the role that competition, financial innovation and regulation played in their evolving risk behaviors. The paper aims to discuss these issues. The results indicate that the market-based and traditional intermediaries exhibited a period of diverging relative average firm-level risk behavior followed by a period of converging risk behavior. Using the derived firm-level risk measures, the impact of competition, financial innovation and regulatory changes on explaining these changing risk behaviors is explored. The results suggest that regulatory changes (i.e. deregulation) can best explain the relative risk behavior over the divergence period through late 1999 relative to the other two variables. The period from November 1999 through the financial crisis marks the converging risk behaviors across these intermediaries. Over this period, the changing nature of competition played the most important role in driving these behaviors.

Managerial Finance, Vol. 45 No. 12, pp. 1580-1600.