Banking market competition in Europe—financial stability or fragility enhancing?

Abstract

Considering the importance of the competition-stability trade-off, contradictory theoretical predictions, and empirical evidence, its re-investigation from the angle of non-linearity is needed. Therefore, this paper focuses on the association between bank stability and competition in Europe by employing a Boone indicator and alternative competition measures. Bank stability is measured with the z-score and loan loss reserves ratio. System-GMM estimations are carried out on a panel of banks from 27 European Union member countries over the period of 2004–2014. The results confirm that when a linear association between bank stability and competition is assumed, competition-stability argument prevails. However, when potential non-linearity of this association is assumed, the results appear more diverse and complex across different competition proxies. We observe signs of U-shape association between bank stability and competition for the Boone indicator and weaker signs of an inverse U-shape association with Lerner index. This indicates that before taking policy measures, it is important to consider the potentially non-linear association between bank stability and competition and to define which aspect of competition regulators want to address. The results concerning mature and emerging Europe exhibit also some differences, indicating that suitable regulatory approaches applied even within the EU could be rather different.