Exploring the Short- and Long-Run Links from Bank Competition to Risk – Reconciling Conflicting Hypotheses?

E Davis () and Dilruba Karim

No 421, National Institute of Economic and Social Research (NIESR) Discussion Papers from National Institute of Economic and Social Research

Abstract: Using a dataset for the EU-27 covering 1998-2012, this is one of the first studies of banking competition and risk to look at the dynamics of the relation between these variables, to take account of a full 6 year period since the onset of the crisis in 2007, as well as a comparable period before it; and to compare and contrast results using two competition indicators, the H statistic and the Lerner index. Using the H statistics, we find that in the crucial pre crisis period, the change in competition has a positive effect on risk (measured by the Z Score), while there is a overall negative effect of the level of competition on risk. The Lerner index provides results supportive of the hypothesis that there are dynamic relations between competition and risk, in that the change in the Lerner index again correlates positively with risk (i.e. narrower margins when competition increases make banks weaker) while the long run effect of heightened competition is also to increase risk. Testing for the reason for differences in long run effects we find that the H and Lerner differ in their impact on the volatility of profits, a key input to the Z Score risk indicator. There are important implications for the interpretation of results in the literature based on these different indicators.

Keywords: Bank competition; financial stability; EU banking markets; Lerner index; Panzar-Rosse H Statistic; Z Score (search for similar items in EconPapers)
JEL-codes: G21 G28 (search for similar items in EconPapers)
Date: 2014-01
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Persistent link: https://EconPapers.repec.org/RePEc:nsr:niesrd:421

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