Does Institutional Quality Matter in the Relationship Between Competition and Bank Stability? Evidence from Asia

Abstract

Introduction/Main Objectives: This study aims to investigate whether competition impacts bank stability. Furthermore, the study also analyzes the role of institutional quality in a country, such as voice and accountability, political stability, government effectiveness, regulatory quality, the rule of law, and control of corruption, forming the effect of competition on bank stability. Background Problem: Analysis of the relationship between competition and bank stability has been at the center of academic and policy debate. However, the theoretical and empirical research has not concluded whether bank competition leads to more or fewer stable banks. Novelty: We consider institutional quality's role in mitigating the negative impact of competition on bank stability, which has mainly been under-elaborated in prior studies, particularly in using measures from The World Bank’s Worldwide Governance Indicators, which measure how the institutions of each country influence bankers’ and the people's behavior, as part of the cultural system. Research Methods: Using a sample of 427 Asian commercial banks from 2011 to 2019, we employ the generalized method of moments (GMM) estimator and consider loan growth and the cost to income ratio as instrumental variables. Findings/Results: We find robust evidence that competition erodes bank stability. Besides, better institutional quality, especially government effectiveness, regulatory quality, the rule of law, and corruption control in each country are important aspects that promote bank stability and mitigate the negative impact of competition on bank stability. Conclusion: Competition has a negative impact on bank stability. Meanwhile, the quality of institutions can both promote bank stability and mitigate this negative relationship.

Bank stability, performance and efficiency: an experience from West Asian countries

“…As a result, our data support our hypothesis (H1) that increased financial profitability improves bank stability. These findings comply with the findings of Mkadmi et al (2021) and are inverse to the findings of Muizzuddin et al (2021). NII ratio exerts positive significant relation with bank stability at a 1% level in model 2 to model 6 and 10% level in model 7.…”

“…The eventual effect of greater competition on stability is determined by which factors take precedence. Nevertheless, Muizzuddin et al (2021) reveal in his study that NIM has a negative significant relationship with bank stability. Tabak, Gomes and da Silva Medeiros (2015) studied the drivers of commercial bank stability in Brazil over 11 years.…”

“…Table 1 lists the dependent, explanatory and control variables used in the study, as well as their associated computations. The first independent variable in our study is NIM which we found in (Mkadmi et al, 2021;Muizzuddin et al, 2021) past research as calculated by net interest income to total assets as a measure of bank profitability. NIM stands for "interest income minus interest costs divided by interest-bearing assets," and it is a measure of the profitability of the banking industry.…”

“…The first independent variable in our study is NIM which we found in (Mkadmi et al. , 2021; Muizzuddin et al. , 2021) past research as calculated by net interest income to total assets as a measure of bank profitability.…”

“…When NIM is taken into consideration, Ali (2015), Borio (2003) and M€ orttinen Poloni, Sandars and Vesala (2005) found the drivers of bank profitability have a clear association with the stability of the banking sector. However, Muizzuddin, Tandelilin, Hanafi and Setiyono (2021) reveal that NIM has a negative impact on bank stability. Furthermore, when we take into account NII, there also has been a lot of argument about it.…”