Reply #1: Bank Concentration, Competition, and Crises: [View All]

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Abstract:

Motivated by public policy debates about bank consolidation and conflicting theoretical predictions about the relationship between bank concentration, bank competition and banking system fragility, this paper studies the impact of national bank concentration, bank regulations, and national institutions on the likelihood of a country suffering a systemic banking crisis. Using data on 69 countries from 1980 to 1997, we find that crises are less likely in economies with more concentrated banking systems even after controlling for differences in commercial bank regulatory policies, national institutions affecting competition, macroeconomic conditions, and shocks to the economy. Furthermore, the data indicate that regulatory policies and institutions that thwart competition are associated with greater banking system fragility.

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Introduction

The consolidation of banks around the globe is fueling an active public policy debate on the impact of consolidation on financial stability. Indeed, economic theory provides conflicting predictions about the relationship between the concentration and the competitiveness of the banking industry and banking system fragility. Motivated by public policy debates and ambiguous theoretical predictions, this paper investigates empirically the impact of bank concentration and bank regulations on banking system stability. Some theoretical arguments and country comparisons suggest that a less concentrated banking sector with many banks is more prone to financial crises than a concentrated banking sector with a few banks (Allen and Gale, 2000, 2004).

First, concentrated banking systems may enhance market power and boost bank profits. High profits provide a “buffer” against adverse shocks and increase the charter or franchise value of the bank, reducing incentives for bank owners and managers to take excessive risk and thus reducing the probability of systemic banking distress (Hellmann, Murdoch, and Stiglitz, 2000; Besanko and Thakor, 1993; Boot and Greenbaum, 1993, Matutes and Vives, 2000).

Second, some hold that it is substantially easier to monitor a few banks in a concentrated banking system than it is to monitor lots of banks in a diffuse banking system. From this perspective, supervision of banks will be more effective and the risks of contagion and thus systemic crisis less pronounced in a concentrated banking system. According to Allen and Gale (2000), the U.S., with its large number of banks, supports this 1See Group of Ten (2001), Bank for International Settlements (2001), International Monetary Fund (2001). See Carletti and Hartmann (2003) and Boyd and De Nicoló (2005) for an overview of the literature. 2Rather than focusing on the links between concentration and the portfolio decisions of banks, Smith (1984) holds banks’ asset allocation decisions constant and examines the liquidity side of the balance sheet. He shows that less competition can lead to more stability if information about the probability distribution of depositors’ liquidity needs
“concentration-stability” view since it has had a history of much greater financial instability than the U.K or Canada, where the banking sector is dominated by fewer larger banks.

An opposing view is that a more concentrated banking structure enhances bank fragility. ...>

http://www.econ.brown.edu/fac/Ross_Levine/Publication/Forthcoming/Forth_JBF_3RL_Concentration.pdf