Abstract:
Purpose – Under the traditional franchise value paradigm, competition in banking markets is
considered to be risk enhancing because of its tendency to raise interest rates on deposits. Taking a
contrarian view, Boyd and De Nicolo (2005) have argued that competition in the loan market can lead to
lower interest rates and hence reduce bank risk-taking. Following these contradictory theoretical
results, the empirical evidence on the relationship between risk and competition in banking has also
been mixed. This paper analyses the competition–stability relationship for the Indian banking sector
for the period 1999-2000 to 2012-2013.
Design/methodology/approach – Banking competition is measured using structural measures of
concentration, namely, five-bank concentration ratios and the Herfindahl-Hirschman Index as well as a
non-structural measure of competition – the Panzar-Rosse H-Statistic. Panel regression methods are
used to estimate the relationships.
Findings – Our results show that while concentration leads to lower levels of default, market and asset
risks, it exacerbates the levels of capital and liquidity risks.
Practical implications – These results have interesting implications for banking sector policy in
emerging economies. For instance, any strategy on entry of new banks has to be carefully coordinated
with supervisory efforts and macro-prudential policy to derive the benefits of greater competition in the
banking industry.
Originality/value – This is the first paper that analyses the competition – stability relationship using
a large number of alternative measures for the banking sector, an emerging economy.
Description:
Journal of Financial Economic Policy, Vol. 8 No. 1, 2016, pp. 95-119
