Banking sector concentration, competition and financial stability: the case of the Baltic countries

Abstract

This paper empirically assesses the potential nonlinear relationship between competition and bank risk for a sample of commercial banks in the Baltic countries over the period 2000-2014. Competition is measured by two alternative indexes, the Lerner index and the market share, while we consider the Z-score and loan loss reserves as proxies for bank risk. In line with the theoretical predictions of Martinez-Miera and Repullo (2010), we find an inverse U-shaped relationship between competition and financial stability. This then means that above a certain threshold, the lack of competition is likely to exacerbate the individual risk-taking behaviour of banks, and could be detrimental to the stability of the banking sector in the Baltic countries. The threshold is around 0.60 for the Lerner index, and close to 50% for market share in terms of assets. The policy implications are that the existence of such a threshold suggests that the future evolution of the structure of the banking industry in these countries is of critical importance. Specifically, this implies that policy-makers should place greater emphasis on mergers and acquisitions to avoid any significant increase of banking sector concentration.

Concentration in the Banking Sector and Financial Stability: New Evidence

“…Our findings, which are in line with recent studies that have uncovered the presence of nonmonotonicities in the relationship between banking market structure and financial stability (Berger et al, 2009;Bretschger et al, 2012;Beck et al, 2013;Carbó Valverde et al, 2013;Jimenez et al, 2013;Cuestas et al, 2017), suggest that an intermediate degree of concentration may be optimal from a welfare perspective. However, we warn against a normative use.…”

Does banking market power matter on financial stability?

“…Therefore, they face greater risks and create financial instability. There is some evidence from the research to support this view, including Jayakumar et al (2018), Yusgiantoro et al (2018), Cuestas et al (2017), Mensi and Labidi (2015), Soedarmono et al (2011), Jiménez et al (2010 Beck et al (2006), and Keeley (1990).…”

“…Lerner index is also calculated in the researches of Ariss (2010), Soedarmono (2011), Agoraki (2011, Mensi and Labidi (2015) and Yusgiantoro et al (2018). Cuestas et al (2017) also used Lerner index, but combine with market share. Jayakumar et al (2018) also used the Lerner index, but the work was associcated with Boone and H index.…”

Banking Concentration and Financial Stability: New Evidence from a Developing Country

“…Financial stability, which is one of the endogenous latent construct in our model, is estimated along two proportions that comprise of financial resilience and financial volatility. Banks' Z-score (ZS) and ratio of credit provisioning to bank deposit (CB) measure financial resilience (Beck et al, 2013;Cuestas et al, 2017). Volatility of the financial system is represented by standard deviation of bank deposit rate growth (SL), standard deviation of bank lending rate growth (SB) and loan loss reserve to total loan loss (LL) ratio (see Titko et al, 2015;Cihak et al, 2016).…”