The budgetary consequences of government bailouts of large banks in 2009 rejuvenated the long-standing academic debate on the impact of bank competition on the economy.
My paper looks at the effect of a new lender’s entry into a local mortgage market on: 1) the supply of new loans 2) house prices and 3) repossessions in areas around its branches. It’s intuitive that competition increases credits supply and house prices, but it turns out that this comes at a cost. The downside is that banks take more risk and loans in areas with more coemption are more likely to lead to repossessions.
In the paper I use the decision of the European Commission to force the UK’s largest retail bank to divest a part of its business as a shock to the entry of a new lender. In particular I concentrate on markets around divested branches and compare them to the rest of the country. This is a great natural experiment as increased competition is forced by the regulator and not local market conditions.
I find that, house prices increase by around 5% in real estate markets impacted by the shock. However, the effect is uneven across space. It declines with the distance to the affected branch and becomes zero after around 6km. It is stronger in areas with lower income and fewer white residents.
There is also a strong positive effect on the number of transactions.
An interesting innovation of my paper is that it shows changes in house prices after controlling for rents. This is important as it shows that the effect comes from demand for home ownership rather than for housing services. Moreover, it is helpful in adding to the debate on the impact of credit supply on price to rent ratios.
Overall, my results show that increased competition in the banking market can have adverse consequences for risk-taking and financial stability. The attached figure shows that house prices in places that received a branch of the new bank (TSB locations) followed the same trends as the rest of the country for almost 20 years before they diverged at the time of the treatment.