The bank capital-competition-risk nexus - a global perspective

Empirical studies of banking sector risk typically look at either the relationship of competition to risk or bank capital adequacy to risk but rarely integrate the two. This raises an issue of potential bias arising from omission of relevant control variables, and is of particular importance in the light of the introduction of a regulatory leverage ratio in Basel III. To fill this lacuna, we provide estimates for the relation between capital adequacy, bank competition and other control variables and four measures of aggregate bank risk for different country groups and time periods. We use macro data from the World Bank’s Global Financial Development Database over 1999-2015 for up to 120 countries globally.

Results largely support “competition-fragility”, i.e. a positive relation of competition to risk controlling for capital; both capital measures controlling for competition are significant predictors of risk, but signs vary across risk measures; the leverage ratio is much more widely relevant than the risk adjusted capital ratio; and there are marked differences in results between advanced countries and emerging markets. Finally, we find competition drives capital ratios lower in a Panel VAR. We contend that our results using macro data are of particular relevance to regulators undertaking macroprudential surveillance because such data gives a greater weight to large systemic institutions than the more commonly-used bank-by-bank data.