Role of Non-Performing Loans (NPLs) and Capital Adequacy in Banking Structure and Competition

Abstract

This paper analyses the impact of the transition from price-cap regulation (deposit/loan rate control) to rate-of-return regulation ( ROA, NPLs and/or BIS ratio ) on banking industry structure. A simple theoretical mo del of banking competition suggests that the relative dominance of the two objective fu nctions under different regulatory regimes affects the market structure. Imposing more stringent rate-of-return regulation, whilst relaxing price-cap regulation, reduces the e quilibrium number of banks. The result from the theoretical model is also supported by empirical evidence from Korea, which has undergone substantial consolidation in re cent years. The empirical analysis uses a unique data set of the entire commercial ban king sector in Korea between 1976 and 2003, which covers both pre- and post- banking crisis periods.