Bank competition, concentration and credit risk

Abstract

The purpose of this study is to investigate the nexus between the banking sector structure and credit risk. Unlike many other studies that address internal and external factors affecting credit risk, the study addresses banking competition, as the banking sector structure has an impact on banks’ loan portfolios. It also employs macro-level data which provides important implications for regulatory authorities. The study utilizes a fixed-effects model to explore the impact of banking competition on credit risk using a panel dataset comprising 52 countries during the period of 1998-2016. In the study, non-performing loans to total gross loans ratio (NPL) is employed as a proxy of credit risk. Lerner index, Boone indicator, and five-bank asset concentration are used for the measurement of banking competition. The empirical findings show that competition and concentration have different impacts on credit risk. Consistent with the relationship lending literature, increased market power alleviates credit risk. On the other hand, concentration does not have a significant impact on credit risk. In particular, banking competition has a more significant impact on credit risk in countries with high non-performing loan volatility. Given higher market power causes less credit problems, policy makers, especially those who officiate in developing economies, should reassess the pro-competition policies. In addition, increasing income and higher foreign ownership diminish credit risk, whereas higher unemployment and a larger amount of credit trigger credit risk. Therefore, bank managers should follow up macroeconomic factors in their lending decisions. Lastly, it should be kept in mind that these results are obtained from cross-country data and the banking regulations in a specific country may affect the relationship between banking competition and credit risk.