Abstract

The array of empirical studies has highlighted the influence of bank competition on financial stability, credit growth, and the regulatory drivers of competition in banking markets (De-Ramon and Straughan 2020). This study attempts to contribute to research related to the role of bank competition on bank risk-taking by examining two competing views. In the traditional “competition-fragility” view, Jimenez et al. (2013) explain that increased bank competition could threaten the solvency of individual banks. This could erode the franchise value of a bank which could encourage a bank to pursue riskier policies to maintain its profits. These riskier policies could lead to higher non-performing loan ratios and potentially lead to bank failures.

The “competition-stability” view posits that a less intensive competition may result in higher lending rates, which may in turn raise the credit risk of borrowers due to moral hazard issues. The increased default risk could drive more problem loans and greater bank instability. However, such a situation allows a bank to protect its franchise value by pursuing safer policies that contribute to the stability of individual banks (Boyd and De Nicolo 2005).

Since the Philippines does not have official measures of bank competition, the approach is to first construct measures of bank competition based on market power from a unique dataset of balance sheet and income statements for 542 banks operating in the Philippines from March 2010 to December 2020. These measures include the H-Statistic, Lerner Index, and the Boone Indicator. The paper then estimates the impact of these competition measures on solvency risk or the risk of being unable to absorb losses with the available capital across universal bank, thrift bank, and rural/cooperative bank industries.

Using a panel fixed effects model, the study reveals important findings. First, at the industry level, bank competition reduces solvency risk. Specifically, the Boone Indicator which measures efficiency, has the biggest impact on solvency risk among the measures of bank competition. These findings imply that the impact of competition on bank risk depends crucially on the underlying individual bank risk. The results also mean that competitive opportunities remain for smaller U/KBs. Second, cost efficiency plays a significant role in reducing bank risk and improving stability and on bank competition across industries. Third, the relationship between competition and risk is sensitive to other bank-specific characteristics and macroeconomic factors related to the extent of diversification strategy, funding source, capitalization and real GDP growth. Fourth, the findings show the positive and significant impact of changes in the physical banking network on bank risk for U/KBs, but negative for TBs and R/CBs. Fifth, the study initially finds that the pandemic has increased bank risk across banking industries.