The effects of the structure of banking market and funding strategy on risk and return

Abstract

This paper analyses the implications of bank market power and funding structure for risk and return. It employs a sample of 978 banks in 55 countries leading up to the 2008 financial crisis to test for two related hypotheses. First, competition reduces internal capital as the level of market power increases when banks use internal funding to diversify into non-interest income generating activities. Building on these results and employing various specifications of Lerner index and funding strategy, the second test suggests that the relatively low insolvency risk among banks in emerging and developing countries during 2000–2007 is attributed to the high degree of market power and the use of internally generated funds.