Low interest rates and risk incentives for banks with market power

Toni M. Whited, Yufeng Wu, Kairong Xiao

Research output: Contribution to journalArticlepeer-review


The interaction between interest rates and banks’ market power generates a motive for bank risk-taking. Low interest rates depress bank profits from the deposit market as competition from cash intensifies. Limited liability and the consequent low bank market value move banks closer to the convex region of their payoff function and thus lead to more risk-taking. We estimate a model that embodies this intuition. We find that when interest rates are low, over 10% of new loans exceed the number that would be optimal in a counterfactual world with no risk-taking incentives.

Original languageEnglish (US)
Pages (from-to)155-174
Number of pages20
JournalJournal of Monetary Economics
StatePublished - Jul 2021


  • Bank risk-taking
  • Liquidity regulation
  • Low interest rates
  • Market power

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics


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