Bank competition, risk-taking and financial stability: insights from an emerging economy
ISSN: 1059-5422
Article publication date: 20 June 2022
Issue publication date: 3 August 2023
Abstract
Purpose
Amidst the backdrop of a wide array of structural developments that have revolutionized the competitive landscape of Indian commercial banking, this paper aims to empirically examine the role of two external monitoring mechanisms – competition and concentration on financial stability and further highlights the significance of bank-level heterogeneity in the nexus.
Design/methodology/approach
The study uses the Lerner index, defined through a translog specification, as a measure of market power. A system generalized method of moments technique accounts for the dynamic associations among the competition-concentration-stability nexus. The study further examines the moderating effect of ownership, size and capitalization on the nexus. The study also uses the Boone indicator and comments on the competition-bank stability relationship after controlling for bank governance.
Findings
The findings indicate that banks are less stable in a more competitive and higher concentrated environment. Exploring bank-level heterogeneity, first, the authors report that as competition increases, state-owned banks have greater incentives to undertake risky activities than private and foreign banks, which point to implicit sovereign guarantees that characterize the former. Second, the authors document an adverse influence of competition on the soundness of larger banks consistent with the “too-big-to-fail” assertion. Third, results corroborate the disciplinary role of regulatory capital and lend support to stricter capital norms under Basel III in a more competitive environment.
Originality/value
This paper is perhaps the first to capture competition and concentration in a single model; to reconcile conflicting evidence on competition-risk nexus; to shed light on the joint effect of competition and Basel accords for Indian banks.
Keywords
Acknowledgements
The authors would like to thank the editor, competitiveness review (Dr Philippe Gugler) and two anonymous reviewers for their time and valuable suggestions. Bhavya Srivastava would also like to acknowledge the financial support (Junior Research Fellowship) of the University Grants Commission, India.
Citation
Srivastava, B., Singh, S. and Jain, S. (2023), "Bank competition, risk-taking and financial stability: insights from an emerging economy", Competitiveness Review, Vol. 33 No. 5, pp. 959-992. https://doi.org/10.1108/CR-10-2021-0143
Publisher
:Emerald Publishing Limited
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