Abstract
Literature present conflicting views on the effect of bank competition on financial stability. Some argue that competition increases adverse shocks in the financial system while others argue that it reduces the likelihood of such events. The purpose of this study is to further examine this relationship using a more recent systemic banking crises database of Laeven and Valencia (2018). There are 61 countries which had experienced systemic crises during 1996-2017. This study used Lerner index and Boone indicator as proxy measures of competition and three estimation techniques to estimate the relationship. The results indicate that the effect of competition on financial stability varies with estimation techniques and proxy measures of competition and stability. Lerner index indicates that competition increases financial instability while Boone indicator shows the opposite. Thus, this study concludes with mixed evidence on the relationship between bank competition and financial stability.
Highlights
The effect of bank competition on financial system stability has been a controversial issue among researchers and policymakers. Allen and Gale (2004), Keeley (1990), and Marcus (1984) propose that bank competition increases instability in the financial system
Bank competition was measured by using Lerner index and Boone indicator
The estimation results of duration model and logit model find that Lerner index and Boone indicator act differently
Summary
The effect of bank competition on financial system stability has been a controversial issue among researchers and policymakers. Allen and Gale (2004), Keeley (1990), and Marcus (1984) propose that bank competition increases instability in the financial system. The effect of bank competition on financial system stability has been a controversial issue among researchers and policymakers. Zigraiova and Havranek (2016) address this controversial issue using a meta-analysis They collect 31 prior studies on bank competition and financial stability and find conflicting evidence mainly due to issues with selection of countries for the study, different time windows of sampling, use of different proxy measures for competition and stability, and due to heterogeneity in estimation methods. The purpose of this study is to further examine the findings of previous authors using a different sample of countries, in a different sample period, using several proxy measures of bank competition and financial stability, and with various estimation techniques
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