Bank competition, regulations, and stability in developed countries

Abstract

The objective of this dissertation is to first explore the influence of competition on bank stability. It is then examined how bank regulation and supervision variables in a country such as the stringency of capital requirements, restrictions on activities, and the power of supervisory authorities, affect bank stability directly and interact with competition in forming the risk-taking bank behavior. A sample of 6,936 banks in 25 developed countries in various parts of the world is used for the years 2007-2015. The findings show that competition-fragility view holds and the decrease in stability under competition arises from both more volatile profits and lower capitalization ratios. There is no evidence of non-linearity in competition and stability relationship as reported in the recent literature. Capital requirements appear to be a very successful regulatory tool in increasing bank stability, both directly and indirectly through interacting with market power. Lower activity restriction is another effective regulatory instrument to decrease bank risk-taking for any level of market power, but the restrictions on activities decrease bank risk more for banks with lower market power. Lower supervisory power emerges as another useful tool in increasing bank stability through decreasing overall bank risk, regardless of the level of market power. It is finally observed that the 2007-2009 financial crisis negatively influences bank soundness. However, it is found that banks with market power remained to be stable during the crisis period, through having lower profit volatility.