Bank competition, crisis and risk taking: Evidence from emerging markets in Asia

Abstract

This paper investigates the impact on financial stability of bank competition in emerging markets by taking into account crisis periods. Based on a broad set of commercial banks in Asia over the 1994-2009 period, the empirical results indicate that a higher degree of market power in the banking market is associated with higher capital ratios, higher income volatility and higher insolvency risk of banks. In general, although banks in less competitive markets hold more capital, the levels of capitalization are not high enough to offset the impact on default risk of higher risk taking. Nevertheless, during crisis periods, specifically the 1997 Asian crisis that has directly affected Asian banks, market power in banking has a stabilizing impact. A closer investigation however shows that such findings only hold for countries with a smaller size of the largest banks, suggesting that the impact of bank competition is conditional on the extent to which the banking industry may benefit from too-big-to-fail subsidies. Overall, this paper has policy implications for bank consolidation policies and the role of the lender of last resort. JEL Classification: G21, G28Keywords: bank competition, moral hazard, financial crisis, Asia *Coresponding author. Tel: +33-555-14-92-05 a E-mail addresses: wsoedarmono@worldbank.org, fmachrouh@groupeiscae.ma, amine.tarazi@unilim.fr. The contents of this paper are the sole responsibility of the author and can under no circumstances be regarded as reflected the position of the World Bank, its executive directors or countries they represent.Electronic copy available at: http://ssrn.com/abstract=1633394 2 Bank competition, crisis and risk-taking: Evidence from emerging markets in Asia AbstractThis paper investigates the impact on financial stability of bank competition in emerging markets by taking into account crisis periods. Based on a broad set of commercial banks in Asia over the 1994-2009 period, the empirical results indicate that a higher degree of market power in the banking market is associated with higher capital ratios, higher income volatility and higher insolvency risk of banks. In general, although banks in less competitive markets hold more capital, the levels of capitalization are not high enough to offset the impact on default risk of higher risk taking. Nevertheless, during crisis periods, specifically the 1997 Asian crisis that has directly affected Asian banks, market power in banking has a stabilizing impact. A closer investigation however shows that such findings only hold for countries with a smaller size of the largest banks, suggesting that the impact of bank competition is conditional on the extent to which the banking industry may benefit from too-big-to-fail subsidies. Overall, this paper has policy implications for bank consolidation policies and the role of the lender of last resort. JEL Classification: G21, G28

Market Structure, Financial Intermediation and Riskiness of Banks: Evidence from Asia Pacific

“…Liu et al (2012) also find the similar results for Southeast Asian banks in which higher bank competition derived from the Panzar-Rosse approach is not associated with higher bank risk taking. As well, Soedarmono et al (2013) indicate that higher market power in Asian banking is associated with higher bank moral hazard, although banks hold a higher capital ratio.…”

“…Our paper extends the literature in several directions. First, a large number of studies rely on bank concentration or Herfindahl index measures to assess the degree of bank competition, while our present study employs the non-structural measure of bank competition derived from the new 6 industrial organization approach following Soedarmono et al (2011;2013). Second, prior studies focus on the immediate impact of bank market structure, while this study also explores whether today's bank risk, and loan growth is determined by last year's bank market structure.…”

“…These include Soedarmono et al (2011) and Soedarmono et al (2013). Specifically, the degree of bank competition is computed using the system of equations as follows: Moreover, it C is defined by total expenses, it q by total earning assets, it d by total deposits and short-term funding, it w by the ratio of operating expenses to total assets, it R by total revenue, it r by the ratio of interest expenses to total deposits, it p by the ratio of total revenue to total earning assets.…”

“…Second, substantial consolidations in the banking industry also occurred in Asia Pacific after the 1997 Asian crisis. Specifically, bank consolidations have grown significantly reaching 25% per year as of 2003 (Santoso, 2009;Soedarmono et al, 2013). In addition, foreign direct investment (FDI) in banking also has increased from US$ 2.5 billion over the 1991-1995 period to US$ 67.5 billion over the [2001][2002][2003][2004][2005] period and hence, Asian countries have become the second largest recipient of FDI in banking after Latin American countries (Domanski, 2005;Moshirian, 2008;Soedarmono et al, 2013).…”

“…Specifically, bank consolidations have grown significantly reaching 25% per year as of 2003 (Santoso, 2009;Soedarmono et al, 2013). In addition, foreign direct investment (FDI) in banking also has increased from US$ 2.5 billion over the 1991-1995 period to US$ 67.5 billion over the [2001][2002][2003][2004][2005] period and hence, Asian countries have become the second largest recipient of FDI in banking after Latin American countries (Domanski, 2005;Moshirian, 2008;Soedarmono et al, 2013). These financial landscape changes in Asia Pacific are more likely to affect 3 bank market structure which can in turn alter the behavior of banks in terms of lending activities and risk taking.…”