How Market Power Influences Bank Failures: Evidence from Russia

Abstract

A vast debate in the literature on banking exists on the impact of bank competition on financial stability. While the dominant view is in favor of a detrimental impact of competition on the stability of banks, this view has recently been challenged by Boyd and De Nicolo (2005) supporting the opposite effect. The aim of this paper is to contribute to this literature by providing the first empirical investigation of the role of bank competition on the occurrence of bank failures. We analyze this issue on a large sample of Russian banks for the period 2001-2007 by measuring bank competition with the Lerner index. The Russian banking industry is a unique example of an emerging market which has undergone a large number of bank failures during the last decade. Our findings clearly support the view that greater bank competition is detrimental for financial stability. This result is robust to tests controlling for the measurement of market power, the definition of bank failure, the set of control variables, the linear specification of the relationship. The normative implications of our findings therefore suggest that measures increasing bank competition could weaken financial stability.