Market power and stability of financial institutions: evidence from the Italian banking sector

This paper explores the relationship between bank market power and stability of financial institutions in Italy between 2001 and 2012. Relying on highly territorially disaggregated data at labor market areas level, we estimate the impact of bank market power and other explanatory variables on a proxy of risk-taking behavior such as the banking ‘‘stability inefficiency’’ derived simultaneously from the estimation of a stability stochastic frontier. The paper concludes that market power affects risk-taking behavior in a non-linear way as the inefficiency of financial stability has a U-shaped relationship with respect to the measure of bank market power and bank size is an essential factor in explaining this association.