Bank Competition and Financial Stability: A Comparative Study of Mutual Savings Banks and Commercial Banks in Korea

Abstract

This study examines the influence of competition and concentration on financial stability in the Korean financial industry. Specifically, we test two alternative hypotheses: the competition-fragility hypothesis versus competition-stability hypothesis by using the sample of two different types of banks − Korean commercial banks and mutual savings banks (MSBs). Using measures for the competitive level and financial stability such as the Boone Index and Z-score, we find that the relationship between competition and stability varies depending on the characteristics of financial institutions. In commercial banks as well as MSBs, however, our estimated Boone Indices suggest that competition was much higher before the recent global financial crisis, but after then it has gradually declined. As Boyd and De Nicolo (2005) suggest, competition has a positive effect on the stability of MSBs with greater business risk and weaker corporate governance. In reality, higher concentration and risk-shifting effects in a less competitive loan market have increased default risks of some MSBs since the recent crisis. Commercial banks, on the contrary, tend to be less stable when they face competition pressure while the relationship is nonlinear.

Keywords: Bank Competition, Risk-taking, Bank Stability, Risk Shifting

JEL Classification: G21, G23, L01