The bank capital-competition-risk nexus – A global perspective

https://doi.org/10.1016/j.intfin.2019.101169Get rights and content
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Highlights

  • We estimate the relation between banking sector risk, capital and competition.

  • Global macro data gives more weight to systemic institutions than bank-by-bank data.

  • Results support a positive relation of competition to risk, controlling for capital.

  • Both leverage and risk adjusted capital predict risk; signs vary across risk measures.

  • Competition drives capital ratios lower, underlining the importance of its monitoring.

Abstract

Empirical studies of banking risk, be it at the institution or sector level, typically focus on either the relationship of competition to risk or bank capital adequacy to risk, but only a subset of studies integrate the two. Lack of integration entails potential bias arising from omission of relevant control variables, and accurate assessment of the interrelations is particularly important in the light of the introduction of a regulatory leverage ratio alongside risk-adjusted capital adequacy in Basel III, as well as macroprudential surveillance and policy which seeks to forecast, assess and control risk at a sectoral level. To advance the literature, we provide estimates for the relation between capital adequacy, bank competition and four measures of aggregate bank risk for different country groups and time periods. Our modelling approach uses control variables that capture aspects of banks’ business models that contribute to financial stability, aggregated to the level of the banking sector. We use macro data from the World Bank’s Global Financial Development Database over 1999–2015 for up to 112 countries globally. We contend that use of macro data means our results are of particular relevance to regulators undertaking macroprudential surveillance, because such data gives a greater weight to large systemic institutions than the more commonly-used bank-by-bank data. Results largely support “competition-fragility”, i.e. a positive relation of competition to risk controlling for capital; both capital measures controlling for competition are significant predictors of risk, but signs vary across risk measures; the leverage ratio is just as widely relevant as the risk-adjusted capital ratio; and there are some differences in results between advanced countries and emerging market economies. Finally, we find competition drives capital ratios lower in a Panel VAR.

Keywords

Macroprudential policy
Bank regulation
Risk-adjusted capital ratio
Bank leverage ratio
Banking competition
Bank risk
Logit
GMM and VAR panel estimation

JEL Classification

E58
G28

Cited by (0)

We thank the editor, Jonathan Batten, an anonymous referee, Ray Barrell, John Fell, Claudia Girardone, Charles Goodhart, John Hunter, Michael Straughan, Fang Xu and participants in seminars at the Bank of England and Brunel University for helpful comments.

1

Brunel University, Uxbridge, Middlesex, UB8 3PH, UK.

2

Fellow, NIESR, 2 Dean Trench Street, Smith Square, London SW1P 3HE, UK.

3

Brunel University, UK.