Does bank competition contribute to financial stability?

Abstract

The relationship between bank competition and financial system stability is indeed very complex. At present, there is still a controversial debate on the two opposing views of the relationship. Under the traditional view called competition-fragility, the hypothesis suggests that a more competitive banking system is less stable. On the contrary, under the recent view called competition-stability, the hypothesis suggests that a more competitive banking system is more stable. This paper, therefore, attempts to fill in the literature gap by using a sample of 81 countries including both developed and developing countries from 2000 to 2013. The results reveal that the relationship between bank competition and financial system stability can vary across different market characteristics, specifically when the segmentation is based on accessibility to funding via financial market and size of credit relative to a country’s GDP. These findings have significant policy implications and help to analyse the effect of competition in financial sector to its stability.