Bank competition and financial stability in asia pacific

Bank competition & financial stability in Asia Pacific Xiaoqing(Maggie) Fu, Yongjia(Rebecca) Faculty of Business Administration, University of Macau Bangor Business School, Bangor University, UK

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Journal of Banking & Finance ⓒ 2013 Elsevier B.V. All right reserved.

Efficiency Analysis on Financial Institutions @ NCCU

Stability Competition

Sometimes we trade off several critical issues

Concentration Regulatory

vs.

14 Asia Pacific Economics

2003 - 2010

4069 banks

The key pointThis paper proposed

1. Greater concentration foster financial fragility.

2. Tougher entry restrictions may benefit bank stability.

3. Several issues has been highlighted in this work.

# The lower pricing power induces risk exposure as well.

# Deposits insurance scheme⇡ financial soundness ⇣

# To prevent excessive concentration

# To improve the efficiency of resource allocation

Agenda

Background introduction | Related literature | Basic research idea

Today’s presentation

Methodology | Data description | Descriptive statistics

Empirical results | Conclusions | Future work for term paper

123

1.

Several policy debatesSince “The great crisis”

There is some impact on financial stability and banks’ competition. (Beck, 2008; Carletti, 2008; …)

Traditional competition-fragility view, competition leads to great stability. A less competitive banking 1

market may lead to more risk-taking if the big banks are though to be too important to fail. (Marcus, 1984 ; …)

Several policy debatesSince “The great crisis”

As we mentioned, there exists positive link between banks’ competition and financial stability. (Boyd, 2005)

Some researchers argued it is nonlinear link. (2010)

Berger is of the opinion that competition and concentration might coexist and simultaneously 2

induce the banking stability and fragility. (2009)

Several policy debatesSince “The great crisis”

Deregulation and excessive competition have both been highlighted as a factor of “The credit crunch .”

Some researchers present the view of relationship between banking competition and stability for Asia Pacific region. 12 Asian economies and 4 South East Asian countries have been covered in their competition-stability nexus work. (Soedarmon,2011; Liu, 2012)

What’s different ?

The author extends previous empirical literature in several respects.

In this paperSomething different …

Previous work pay more attention to apply Z-scores.

The author extends the analysis of the probability of bankruptcy

using the Black & Scholes(1973) and Merton(1974) contingent

claim approaches.1

# Accounting-based models

# Market-based measures{ }

# Market-based measures

Stock prices reflect all available information in efficient markets.

1

2

3

Firms accounting policies have no influences on market variables.

Market prices reflect future expected cash flows. Thus, market based approach should be more appropriate to use for prediction purposes.

In this paperSomething different …

Nevertheless, some non-structural indicators have been proposed in

the contestable markets (Baumol, 1982). To examine the concentration,

competition, and stability nexus in Asia Pacific, this two type measures

have been considered.

2 The author includes structural and non-structural measures

of the competition in his work. Competition and concentration are

inversely related Structure-Conduct-Performance(SCP) model.

In this paperSomething different …

3 Regulatory and institutional environmental factors have both

considered in this work. The author adopt instrumental variable

technique with GMM estimator to address potential endogeneity

problem between competition and risk. (Berger’s idea, 2009)

Literature reviewCompetition & stability

Competitive and less concentrated banking system are more fragile

under traditional hypothesis. Diamond(1984), Williamson(1986) and

others argue more concentrated systems can capitalise on economies

of scale and scope and better to diversify portfolios.

Hence, greater concentration and less competition could reduce

the liability risk and lead to greater stability. (Smith, 1984; Boot,

1993; Allen, 2003; Gale, 2004, )

Literature reviewCompetition & stability

Even, Allan and Gale (2004) claimed that financial crisis are more

likely to occur in the less concentrated systems. Boyd et al. (2004)

stated that large “capital buffer” could not be provided if there

doesn’t exist concentrated banking systems or monopolistic larger

banks.

However, “too large to fail” issue must still be considered by

policymakers. (Mishkin, 1996, 2006 ; Barth 2012) Larger banks

often likely lead to generate moral hazard problem. (Kane 2010)

Literature reviewCompetition & stability

Beck et al.(2006) suggest that bank’s size is positively correlated

with organisation complexity. Monitoring larger banks is harder

than monitoring the small ones. As the firm size increase, the

transparency may decrease.

Many investigations have emerged testing for concentration, competition, & banking

stability relationship across countries.

Empirical literatureAcross several countries

Yeyati and Micco(2007) tested commercial banks from eight Latin

American countries over 1993 - 2002. The finding indicates that a

positive link between bank risk and competition.

Over 3600 European banks and 8900U.S banks have been analysed

for the period from 1995 - 2005 by Schaeck and Cihak(2008). They

find more concentrated banking market benefit the financial stability.

Liu et al (2012) ’s investigation shows that concentration is negatively

associated with bank risk, whereas regulatory restrictions is positively

influenced bank fragility.

Still, it is difficult to predict our experimental results.“

”

“

”

Different channels show different relationship between competition,

banking stability and concentration.

2.

Our panel data modelGeneral form is that…

Bank Risk = f (Concentration, Competition,

Regulator and Institutional Controls, Macro Controls)

Market-based measureThe probability of bankruptcy

P = N(�ln(VAD ) + (u� δ � σ2A

2 )TσA

�T

)

McDonald(2002)’s modified probability is that:

N(.) shows cumulative normal density function VA is value of asset ; u shows return ; T: expiration time D means face value of debt proxied by total liabilities.

Market-based measureSome details shows here:

VA = VE + D

Bharath and Shumway(2008) presented:

σA =VEVAσE +

DVAσD

σD = 0.05+ 0.25 � σE

u = ri,t�1

VE is market value of common equity

σE shows the standard deviation of

daily stock return by the square root

of the trading days in a year.

r means the bank’s stock returns over

the previous year.

Accounting-based measureWe use the Z-score …

The Z- score calculation model is that:

Zit =ROAit + Eit/TAit

σROAit

ROA is the return on assets E/TA is the equity to total assets. σROA is the standard deviation of the return on assets

The Z score is inversely related to the probability of

the bankruptcy which we mentioned the last slide.

Concentration & Competition measure

# Considering the structural indicator, the author use the ratio of assets of three largest banks to the total assets of the banking system as the degree of market concentration measure. (CR3)

# Further, the non-structural indicator, the Lerner index(LERNER) is used to measure the degree of the competition.

Concentration & Competition measure

# Lerner index is calculated as follows:

Lernerit =PTAit � MCTAit

PTAit

P shows the price of total assets by the ratio of total revenues to total assets for bank. 0 < Lerner index < 1,where the perfect competition case implies Lerner index = 0, and the pure monopoly implies Lerner index = 1

Other control variablesFollowing previous works

# Schaeck and Cihak (2008)…

A bank’s asset size (SIZE) is defined as logarithm(total assets size). The ratio of loan-loss provisions to total

1assets (LLT) and the net interest margin are also considered in our work to track the profitability of a bank’s investing and lending activities.

Other control variablesFollowing previous works# Beck et al. (2006) argues bank regulatory policies and national institutions should be considered in the cross countries’ investigation. Thus, the author also

2controls for the banks’ regulations and institutional environ-ments in the investigation of concentration and competition on bank stability.

Table2- Descriptive statistics

Table2- Descriptive statistics

Listed sample Whole sample

Z- score 40.86 39.78

CR3 0.44 0.46

LERNER 0.31 0.32

E-LERNER 0.26 0.27

LLP 1.80 1.69

Table3

2007 - 2009 (Panel A)The probability of bankruptcy

Probability of bankruptcy

2007 0.1862

2008 0.2561

2009 0.3369

2010 0.1523

2007 - 2009 (Panel A)Lerner’s index

Lerner’s index(competition) CR3(concentration)

2006 0.3116 0.4175

2007 0.3028 0.4297

2008 0.2588 0.4472

2009 0.3151 0.4483

2010 0.3336 0.4550

Panel BRisk Exposure on average

Japan(0.2616)

Taiwan(0.1974)

Korea(0.1872)

Singapore(0.0670)

Hong - Kong(0.0477)

Malaysia(0.0362)

Market-based risk measure

>

3.

Empirical results

Two different risk exposure indicators are used as the dependent variables that proxy for financial stability.

We use the First Stage F-test and the Hansen’s J test to test for the relevance and validity of the instruments of the degree of market power, respectively.

We would present that …

Table3

Empirical results

of bank concentration is significantly positive, indicating that banks in more concentrated markets face greater risk.

(1) suggesting that increases in the degree of bank pricing power are positively related to individual bank stability in Asia Pacific. Meanwhile, the coefficient

1

We could know that …

Empirical results

The results findings are not surprising for banks operating in Asia Pacific. The protected, larger2

We could know that …

banks in these concentrated banking systems channel resources to ‘‘priority sectors’’. “Too large to fail” would occur in this credit culture. In addition, credit deposits insurance may occur the moral hazard problem.

Conclusions

Main conclusionsThis paper presented

12

Neutral view of competition-stability nexus. Indicate the competition-fragility and competition-stability simultaneously apply to Asia Pacific markets.

Tougher entry restrictions may enhance bank stability, whereas stronger deposit insurance schemes negatively influence financial soundness.

Main conclusionsThis paper presented

3To prevent excessive concentration, regulators should adopt a more cautious approach to evaluating and approving merger and acquisitions at the national level.

To improve the efficiency of resource allocation, regulators should encourage financial innovation among banks based on the premise of effective risk management.

Main conclusionsThis paper presented

4 Deposit insurance schemes appear to foster moral hazard and risk shifting behaviour so any policy moves

to increase coverage should be treated with caution as this could have the unintended consequence of boosting risk as opposed to promoting stability.

How about my final paper ?

Thanks for your time.