Competition, bank fragility, and financial crisis

Abstract

This paper examines how competition affects bank fragility and how this relation varies in normal times and during a financial crisis using the data from Indonesian commercial banking industry. The author finds significant evidence, both statistically and economically, that more competition reduces bank fragility. In particular, the author finds that a decrease in Herfindahl -Hirschman Index (HHI) of deposits by 100 points leads to an increase in bank Z-score by 14.22 percent from its mean. Similarly, a decrease in HHI of loans by 100 points leads to an increase in Z36 by 20.44 percent. This finding is consistent across different kinds of robustness tests, including endogeneity, as well as alternative bank fragility and competition measures. However, this competition-stability nexus holds only in normal times and is reversed during a financial crisis. This suggests that the impact of competition on bank fragility is conditional on the economic condition.

Innovative ways of thinking concerning economic governance after the global financial crisis

“…For details about financial cycles and their behavioral aspects see De Grauwe (2012). 6 In line with that definition and approach of stability, Hanggraeni (2018) argues that in the banking sector -even if the impact of competition on bank fragility is conditional on the economic condition -in general more competition reduces bank fragility. 7…”

Competition and Banking Industry Stability: How Do BRICS and G7 Compare?

“…Several approaches have been utilized to delineate the link between competition and stability in the banking industry. Most common techniques include ordinary least square (OLS) regression (Lee & Chih, 2013), fixed and random effects models (Bahadur & Sharma, 2016; Maji & Hazarika, 2019; Mishi et al, 2016), two-stage least square (2SLS) and three-stage least square (3SLS) models (Amidu & Wolfe, 2013; Schaeck & Cihak, 2012), and generalized method of moments (GMM) (Akande & Kwenda, 2017; Berger et al, 2009; Hanggraeni, 2018; Hussain & Bashir, 2020; Klomp & De Haan, 2015; Shijaku, 2017b). Following Bascle (2008), this study uses Instrumental Variable (IV) regression with the generalized method of moments (GMM) estimator to produce reliable and consistent estimates and address concerns about endogeneity (Bikker & Vervliet, 2018; Ullah et al, 2018).…”

“…The dependent variable is stability (STAB), which is proxied by Z -scores (Capraru & Andries, 2015; Li, 2019). High Z -scores indicate a low risk of vulnerability (Beck et al, 2013; Fiordelisi & Mare, 2014; Hanggraeni, 2018). Lag of stability by one period (STAB i,t −l ) is included in the panel model to reflect the idea that the level of stability in a prior period could affect stability in the future (Fiordelisi & Mare, 2014).…”

“…The competition-stability studies suggest that more market power (i.e., less competition) allows banks to seek high rates on loans, thereby elevating banks’ risk and the likelihood of default by borrowers (Berger et al, 2009; Hanggraeni, 2018). The competition-fragility studies present that less market power (i.e., more competition) causes a decline in profitability and franchise value, thus increasing banks’ openness to more risks (Berger et al, 2009; Hanggraeni, 2018).…”

“…The competition-stability studies suggest that more market power (i.e., less competition) allows banks to seek high rates on loans, thereby elevating banks’ risk and the likelihood of default by borrowers (Berger et al, 2009; Hanggraeni, 2018). The competition-fragility studies present that less market power (i.e., more competition) causes a decline in profitability and franchise value, thus increasing banks’ openness to more risks (Berger et al, 2009; Hanggraeni, 2018). Concerning concentration-stability, studies (e.g., Berger et al, 2004; Rahim et al, 2019) insinuate that concentration enhances stability, which is plausible as the high cost of failure in concentrated markets inclines banks to be prudent (Uhde & Heimeshoff, 2009).…”