Bank Competition, Diversification and Financial Stability

27 Pages Posted: 20 Aug 2009 Last revised: 20 Jul 2011

Mohammed Amidu

University of Ghana - Business School

Simon Wolfe

University of Southampton - Southampton Business School

Multiple version iconThere are 2 versions of this paper

Date Written: February 12, 2009

Abstract

A tension exists in the current literature as to whether or not competition contributes to banking stability. On the one side, proponents of the so called ‘franchise value hypothesis’ argue that banks with greater market power are able to protect their franchise value because they are not income constrained. On the other side, are those who reject this hypothesis and hold the view that banks in uncompetitive markets are prone to originate riskier loans which are detrimental to their stability. We provide additional empirical insight into these conflicting views by arguing that competition affects bank solvency not only through the traditional channels, but also through banks’ decisions to diversify their business activities. We use the H-statistic, a non-structural methodology put forward by Panzar and Rosse (1987) to measure banking sector competition for 704 banks across 32 countries during the period 2000 - 2007. Our results show that competition increases bank stability because of the decisions banks make to diversify their activities. We also find that regulatory initiative which restricts banking activities imposes severe entry requirements, requires high regulatory capital and provides effective official supervisory power influences banks’ decision to diversify.

Keywords: bank competition, diversification, financial stability, banking regulation

JEL Classification: G21, G33, G38

Suggested Citation

Amidu, Mohammed and Wolfe, Simon, Bank Competition, Diversification and Financial Stability (February 12, 2009). 22nd Australasian Finance and Banking Conference 2009. Available at SSRN: https://ssrn.com/abstract=1341863 or http://dx.doi.org/10.2139/ssrn.1341863

Mohammed Amidu (Contact Author)

University of Ghana - Business School ( email )

P.O. Box LG 78
Legon
Accra, Greater Accra LG 78
Ghana

Simon Wolfe

University of Southampton - Southampton Business School ( email )

Highfield
Southampton S017 1BJ, Hampshire SO17 1BJ
United Kingdom

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