Do competition and market structure affect sensitivity of bank profitability to the business cycle?

Abstract

This study aims to determine whether competition and market structure explain heterogeneity in the cyclicality of bank profitability. To answer this question, we consider a large panel of individual bank-level data covering over 8000 banks in more than 100 countries. This study controls for market power and market structure as proxies for the competitive environment and net interest margin (NIM), as well as return on assets (ROA) and return on equity (ROE) as proxies for bank profitability. The results show that decreased competition is related to an increase in the procyclicality of NIM and ROA. Therefore, our results are consistent with the competition–stability perspective. A perfectly competitive environment is associated with the enhanced procyclicality of NIM and ROA in high-income countries, and with the declined procyclicality of all profitability measures in low-income countries. Market structure does statistically significantly affect profitability but seems is important only for the procyclicality of ROE.