Banking Sector Reform, Competition and Bank Stability: An Empirical Analysis of Transition Countries

Abstract

This study tests the impact of banking sector reform and competition on bank stability based on the unbalanced data from 14 transition countries during the period from 1998 to 2016. The initial results not only highlight the positive relationship between the market power and bank fragility, but also confirm the positive relationship between bank reform and stability. Our findings also show that higher activity restrictions, greater stringency on capital requirements, higher declaring insolvency power, more explicit guidelines for assets diversification, higher private monitoring, and better financial statement transparency enhance bank stability and improve financial soundness. The results also suggest that the positive relationship between bank competition and stability are more pronounced if the bank sector experienced a higher level of bank reform and has better financial information transparency. The effect of competition in reducing risk is less pronounced if the banks are exposed to higher activity restrictions and grater stringency on capital requirements, particularly in more competitive markets.

Keywords: Banking Sector Reform; Competition; Bank Stability; Regulation; Transition Countries

JEL Classification: G21; G28