Abstract
We analyze the effects of market concentration and income diversification on banking performance. We used a sample of 134 countries for the period 1994-2011 and used the GMM estimator proposed by Arellano and Bover (1995). Our results show that market concentration and income diversification have a positive and non-linear effect on bank performance. The non-linearity suggests that the positive effect is reversed if the banking industry has high levels of market concentration and income diversification. During an economic crisis, the banking industry reduces diversification to support its performance. These results are relevant for the design of financial policy and banking strategies.
Highlights
In recent decades, and with increased financial liberalization worldwide, the banking industry has experienced significant changes
The positive effect of market concentration on banking performance is not persistent, due to this adverse selection problem and the creation of an environment conducive to a “quiet life”. According to these arguments we propose the following hypothesis: H1: Market concentration has a non-linear effect on banking performance
The impact of globalization in international markets, the increase in foreign investment and financial liberalization, have allowed banks to diversify their product and income portfolios, and concentrate the banking market. These phenomena have had an impact on bank performance
Summary
With increased financial liberalization worldwide, the banking industry has experienced significant changes. Several studies have shown that market concentration improves banks’ performance since it allows them to have greater control over industry prices (Shepherd, 1983; Molyneux & Thornton, 1992). In this scenario, larger banks obtain greater advantages as they are able to scale the provision of financial services (Berger, 1995). Other studies have provided contrary findings, opening again the debate surrounding market structure and banking performance. These studies argue that when the banking sector is excessively concentrated, their resulting pursuit of the “quiet life” reduces their efforts to maximize profits (Smirlock, 1985; Demirgüç-Kunt & Huizinga, 1999; Staikouras & Wood, 2004)
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