Abstract
Financial deregulation after financial repression during 1980s and 1990s has stimulated a fierce competition among banks across the world. In pace with this, banking industry of Bangladesh is also experiencing an intense competition, since it is composed of a large number of banks. Considering this upsurge, our study aims to explore the impact of competition and efficiency on financial stability of Bangladeshi banks over 2009–2017. For exploring this nexus, we calculate Boone indicator and Z-score, construct banking efficiency index by principal component analysis, using bank-level data to measure competition, stability and efficiency, respectively, and analyze the impact of efficiency on financial stability at different levels of competition. We address the endogeneity of the estimation by employing two-step system GMM and different robustness checks. The findings of our study suggest a nonlinear competition–stability relationship, and though efficiency contributes to stability, the impact is moderated in the presence of competition. Our findings are robust to alternative measures of competition, stability and control variables, which could be useful for policy makers to formulate strategies and policies to maintain financial stability.
Highlights
The liberalization of the financial system and reforms of banking industries across the borders have altered the functional and competitive environment for banks
The rising trend of nonperforming loan ratio (NPL) is a looming threat to the banking sector in Bangladesh that may stem from the increasing degree of competition, as fierce competition often lowers profitability and induces banks to compromise the standard of lending that leads to a rise in credit risk and inefficiency and eventually affects financial stability
Data To analyze whether bank competition and efficiency influence bank stability, bank-level data of competition, efficiency, financial stability and bank-level control variables—bank size and liquidity—are sourced from financial statements of concerned banks which are available at their websites and Dhaka Stock Exchange library
Summary
The liberalization of the financial system and reforms of banking industries across the borders have altered the functional and competitive environment for banks. The rising trend of NPLs is a looming threat to the banking sector in Bangladesh that may stem from the increasing degree of competition, as fierce competition often lowers profitability and induces banks to compromise the standard of lending that leads to a rise in credit risk and inefficiency and eventually affects financial stability. It is worth investigating the nexus between competition, efficiency and stability from Bangladesh’s perspective
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